Which of the following statements is most correct?
A) The cost of capital used to evaluate a project should be the cost of the specific type of financing used to fund that project.
B) The cost of debt used to calculate the weighted average cost of capital is based on an average of the cost of debt already issued by the firm and the cost of new debt.
C) One problem with the CAPM approach to estimating the cost of equity capital is that if a firm's stockholders are, in fact, not well diversified, beta may be a poor measure of the firm's true investment risk.
D) The bond-yield-plus-risk-premium approach is the most sophisticated and objective method of estimating a firm's cost of equity capital.
E) The cost of equity capital is generally easier to measure than the cost of debt, which varies daily with interest rates, or the cost of preferred stock since preferred stock is issued infrequently.

Question

Quizplus · Accepted Answer

The CAPM approach assumes that stockholders are well diversified, meaning that beta may not accurately reflect the true risk of a firm's investment. This can lead to incorrect cost of equity capital estimates. Choices A, B, D, and E are all incorrect statements.

Which of the Following Statements Is Most Correct