Final answer:
The cost of capital for a firm is influenced by factors like interest rates, risk, and opportunity cost, impacting investment decisions such as investing $183 million at an effective 4% return when the nominal rate is 9% mitigated by a 5% societal return.
Step-by-step explanation:
The cost of capital for a firm – when we allow for taxes, bankruptcy, and agency costs – takes into account several factors that affect how much the firm will decide to invest.
Factors such as interest rates, the risk of different financial investments, and the opportunity cost of capital are crucial determinants of the firm's investment decisions. For example, if the firm faces a 9% interest rate as the cost of financial capital, but can capture a 5% return to society, it effectively earns a 4% rate of return.
This adjusted return rate influences how much the firm will choose to invest, in this case, $183 million as opposed to a lower investment without considering the return to society.