A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?

A. Assign every project a rate equal to the firm's cost of equity

B. Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity

C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

D. Determine the best pure play rate for each project

E. Assign every project a rate equal to the market rate of return at the time of the proposal

Question

Leonard Newman

Business

15 July, 00:52

A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?

A. Assign every project a rate equal to the firm's cost of equity

B. Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity

C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

D. Determine the best pure play rate for each project

E. Assign every project a rate equal to the market rate of return at the time of the proposal

+2

Answers (1)

Know the Answer?

Cristofer Kirby · Answer 1

The correct answer is letter "C": Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment.

Explanation:

The Weighted Average Cost of Capital or WACC is the discount rate used to discount the future cash flows at the moment to value investment projects. The higher the WACC, the less likely that the company is creating value because it has to overcome more expensive borrowing costs to make a profit. Then, it is better to give similar rates to the different risk-investment projects of a company according to its WACC. If needed, adjustments should be made to adapt it to the type of investment vehicle.