The weighted average cost of capital The importance of cost of capital Income Co
ID: 2713423 • Letter: T
Question
The weighted average cost of capital The importance of cost of capital Income Corp. is considering investing in a project in which the risk is greater than the firm's current risk based on any method for assessing risk. Which of the following should management do when evaluating this project? They should always reject the project, because it will increase the firm's risk level. To take the higher risk level into account, they will need to use a discount rate that is greater than the cost of capital to evaluate the project. To take the higher risk level into account, they will need to increase the flotation expenses associated with the project. To take the higher risk level into account, they will need to change the weights on the capital components. Which of the following statements is correct? The cost of raising funds from retained earnings is usually a lot cheaper than the cost of debt financing, because the firm already possesses the funds in retained earnings. When all other factors are held constant, a higher tax rate will lower a firm's WACC only if the firm uses debt A firm's after-tax cost of preferred stock may be significantly less than its before-tax cost, because issuing preferred stock dividends creates a tax shelter.Explanation / Answer
If the project risk is high, a higher discounting rate is required for evaluating project. Risk should give adequate return. Hence, a higher rate than the cost of capital is sued.
Correct option is “To take the higher risk level into account, they will need to use a discount rate that is greater than the cost of capital to evaluate the project”.
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