A project needs to have positive Net present value on CashInflows. Net PV = CF/(1+K) + Cf2/(1+K)^2…
But how do we figure out the discounting rate? The discounting rate to be used is simply the oppurtunity cost of the money that is going to be invested into the project (Machinery,Plant,Process etc). So in case of equity or the owners capital the oppertunity cost is the alternative best use of the capital. In case of the debt it is the increment of loan interest which could have been avoided. To understand the cost of debt is tricky, as the formula assumes that the debt increases by the interest rate [Why so? because it is assumed that the interest is being paid by Further borrowing]. So why further borrowing? We are paying interest from our revenue generated? Its so because here is the assumption (which can be considered more logical) that when we use revenue to pay off our interest liability we are missing the oppurtunity to retire our debt using that revenue. And hence the cost of this decision is the discounting rate.
Is my logic correct? Or is there anything i am missing?