Illustrating Non-Constant Marginal Cost of Capital and the Interdependency of Independent Projects

The simple mechanics of capital budgeting decision techniques are complicated by presence of mutual exclusion, project contingencies, differing risk levels, and unequal lives. This paper examines another such complexity virtually ignored by financial management textbooks but present in virtually all capital budgeting scenarios: project interdependency caused by a non-constant marginal cost of capital (MCC) schedule, a cost schedule representing the reality for business firms. Any capital budgeting decision method using the cost of capital as an input is affected. An example of this complexity is presented in this paper. An expositional exercise concerning the role of cashflow pattern and scale differences in creating differences in total net present value for a capital budgeting decision is presented as well. Finally, an explanation of the isolated role of the non-constant MCC is presented and a proof offered in the paper's appendix