New Environments:incremental cost of funds on an asset

Suppose you have three indivisible assets, A, B and C with internal rates of return 2%, 5% and 10% respectively and initial costs of $1, $4, $5.

Suppose you have $8.0 at 1% and can borrow at 9%. What is the incremental cost of funds on asset B?



First apply the $8 dollars to asset C which has the greatest IRR of 10%. That leaves you with $3. 8-5=3.
Since the assets are indivisible you must spend the $4 on asset B. You only have $3 left so you must borrow $1 from a loan at 9%.
Thus 3 out of the 4 dollars are going to be at a rate of 1% while 1 out of the 4 is at a rate of 9%.

Thus the equation is: (3/4)*0.01+(1/4)*0.09 = 0.03

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