You have just been named the chief financial officer of Fabco, a large metal fabricator located in Chama, New Mexico. The company has long been a user of the net present value method for evaluating its investment projects. The firm undertakes all projects offering a positive net present value, based upon data submitted by the project proposer. Fabco’s weighted cost of capital has been estimated to be 15 percent.
This capital cost has remained approximately constant over the past five years. Over the past 5 years, Fabco has earned a return on assets averaging 8 percent. You are concerned about the apparent disagreement between Fabco’s cost of capital and its earned returns. The CEO has asked you to prepare a report on the situation. What factors (both within and outside of the firm) might account for this apparent discrepancy in performance?