Which of the following would not be an appropriate guideline for determining the

Question

Which of the following would not be an appropriate guideline for determining the interest rate to use in

discounting project cash flows in capital budgeting?

a. for replacement projects, given that their risk is consistent with that of the present

business, use the cost of capital

b. for expansion projects of moderate size, given that their risk is slightly greater than that of

the present business, use the cost of capital, plus a small risk premium of one to three

percent

c. for new ventures, given that their risk can be far greater than current operations, use the

cost of capital plus a risk premium of at most five percent since using anything higher

usually guarantees rejection

d. all of the above are appropriate guidelines

Explanation / Answer

The correct answer is option (D). All the above are appropriate guidelines.

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