8.1 Is each of the following statements true or false? Explain your answers brie

Question

8.1 Is each of the following statements true or false? Explain your answers briefly.

a. Using the same risk-adjusted discount rate to discount all future cash flows ignores the fact that the more distant cash flows are often riskier than cash flows occurring sooner.

b. The cost of capital, or WACC, is not the correct discount rate to use for all projects undertaken by a firm.

c. If you can borrow all of the money you need for a project at 6 percent, the cost of capital for this project is 6 percent.

d. The best way to estimate the cost of debt capital for a firm is to di- vide the interest expense on the income statement by the interest-bearing debt on the balance sheet.

e. One reliable estimate of a privately held firm’s equity beta is the average of the equity betas of several publicly held competitors.

Explanation / Answer

a. True ..It is always very difficult to accurately arrive a cash flow estimate deep into th future thus the discount rate to be used to compensate for this inaccuracy should be greater

b. True..so projects are more risky and a premium should be added to adjust the firms WACC

c. False cost of capital depends on the risk of the project not the source.

d. False, it is necessary to take into consideration additional risk premium which the firm may face to take on more debt which is not reflected in the current interest the firm is paying.

e. False, the equity beta should be average of equty betas of publicly held companies but in the same industry as the private company

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