Final answer:
The question relates to calculating the cost of capital and the weighted average cost of capital (WACC) at Dillon Labs, considering both the interest rate and the return to society. The firm adjusts its investment decisions based on these factors, with the given example showing an effective rate of return of 4% leading to a $183 million investment.
Step-by-step explanation:
The question pertains to the financial management practices at Dillon Labs, specifically the calculation of the cost of capital and the weighted average cost of capital (WACC). The cost of capital refers to the opportunity cost of making a specific investment. It represents the rate of return that could have been earned by putting the same money into a different investment with equal risk. Therefore, it is the minimum return that investors expect for providing capital to the company.
In this scenario, Dillon Labs has differentiated between its specific cost of capital for different sources and its WACC. WACC represents the average rate of return a company is expected to pay its security holders to finance its assets.
From the information given, if the interest rate is 9%, which can be understood as the cost of financial capital, and the firm can capture a 5% return to society, it changes the firm's effective rate. The firm would calculate its investments as if the effective rate of return is 4%, leading them to decide to invest $183 million, a figure adjusted based on the return to society and the cost of financial capital.
Additionally, the financial manager at Dillon Labs is instructed to use specific weights to calculate WACC, which implies allocating different weights to different sources of capital based on their proportion in the overall capital structure. Although the exact weights are not provided in the question, they are critically important in calculating an accurate WACC.