1. Input Inc is considering investing in a project in which the risk is greater

Question

1. Input Inc 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 follwoing should management do when evaluating the project ?

a) 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

b)they should always reject the project, because it will increase the the firm's risk level

c) to take the higher risk level into account, they will need to increase the NPV of the project

d) to take the higher risk level into account,  they will need to increase the IRR of the project

2. Which of the following statements are correct?

a) a firm's WACC should decrease if its tax rate increases but the yield to maturity of its non callable bonds remains the same and all other factors are held constant

b) 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

c) A firm's after-tax cost of preferred stock may be significantly less than the its before-tax cost, because issuing preferred stock dividends creates a tax shelter

Explanation / Answer

1)

Risk and required return has direct relationship. If the risk increases, required return will increase and if risk decreases, required return will decrease. So, there is direct nexus between risk and required return.

Here, project is more risky than firm risk. Hence, it is necessary to use a higher discount rate.

So correct option is (A)

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