1) Why does cost of capital play an important role in decision-making?    2

1) Cost of capital plays a really important role in decision making for a business project to be undertaken or abondoned. It is the cost the firm has to bear for the capital raised through various sources like debt, equity, preferred equity etc. First of all cost of capital is used to find the present values of the future cash flow to assess the Net present value of a project. Based upon this we decide if the project is to be taken or not. If the NPV calculated is greater than 0, the project will add value to the company and hence should be taken.

Another view point is that, every project earns a return, that return shall be greater than the cost of capital to contribute to the earnings of the company. It is like the minimum return a company wants to create value.

2) Return on invested capital is the return a company is earning out of the investments made in numerous projects undertaken by the company. The cost of capital acts like a benchmark that a project must earn at minimum for a project to be considered for the business. Any project that earns the return on invested capital less than the cost of capital should not be undertaken as these are the value destroyers and don't add anything. Projects with Return on invested capital greater than the cost of capital are value creators and should be undertaken to add value to the company and investors.