P.8. Opportunity cost of capital. F&H Corp.continues to invest heavily in a declining industry. Here is anexcerpt from a recent speech by F&H’s CFO:
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     We at F&H have ofcourse noted the complaints of a few spineless investors anduninformed security analysts about the slow growth of profits anddividends. Unlike those confirmed doubters, we have confidence inthe long-run demand for mechanical encabulators, despite competingdigital products. We are therefore determined to invest to maintainour share of the overall encabulator market. F&H has a rigorousCAPEX approval process, and we are confident of returns around 8%on investment. That’s a far better return than F&H earns on itscash holdings. The CFO went on to explain that F&H investedexcess cash in short-term U.S. government securities, which arealmost entirely risk-free but offered only 4% rate ofreturn.
a. Is a forecasted 8% return in the encabulator businessnecessarily better than a 4% safe return on short-term U.S.government securities? Why or why not?
b. Is F&H’s opportunity cost of capital 4%? How inprinciple should the CFOdetermine the cost of capital?
