Is It Appropriate, and If So, Why Is It Appropriate

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Examlex · Accepted Answer

The Answer is Yes, it is appropriate, because construction costs either have little volatility or they are typically not much correlated with financial markets, giving them effectively little risk that cannot be diversified away, hence, little risk that would be "priced" in the capital markets).

Yes, it is appropriate, because the opportunity cost of capital is an expected return, not the contract interest rate on the construction loan. Because of the possibility of loss under default of the construction loan, the construction lender actually faces an expected return on the loan that is substantially below the contract interest rate on the loan, which effectively makes the expected return only slightly above the riskfree rate.

Is It Appropriate, and If So, Why Is It Appropriate

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