If a firm uses its weighted average cost of capital (WACC) to evaluate all capital budgeting projects, which of the following could occur?
A)Projects with little or no risk might be rejected when they actually should be accepted.
B)Projects with significant risks might be accepted when the actually should be rejected.
C)Projects with average risk will always be rejected when they actually should be rejected.
D)All of the above could occur.
E)None of the above could occur.

Question

Quizplus · Accepted Answer

When a firm uses its weighted average cost of capital (WACC) to evaluate all capital budgeting projects, it may face the following issues:
A) Projects with little or no risk might be rejected when they actually should be accepted because the WACC is an average cost of capital that includes both debt and equity financing. Therefore, the WACC may be biased towards higher risk projects.
B) Projects with significant risks might be accepted when they actually should be rejected because the WACC may underestimate the cost of capital for higher risk projects.
C) Projects with average risk will always be rejected when they actually should be accepted is not true because the WACC is calculated based on the overall risk of the firm, and projects with average risk should have a WACC that reflects their level of risk.
Therefore, all of the above could occur when a firm uses its WACC to evaluate all capital budgeting projects.

If a Firm Uses Its Weighted Average Cost of Capital