When using the weighted average cost of capital (WACC) to discount cash flows from a project we assume the following:
I. the project's risk are the same as those of firm's other assets and remain so for the life of the project.
II. the project supports the same fraction of debt to value as the firm's overall capital structure that remains constant for the life of the project.
III. the cash flows from the project is always a perpetuity.
A) I only
B) II only
C) I and II only
D) I, II and III

Question

Quizplus · Accepted Answer

The WACC assumes that the project's risk is the same as the firm's other assets, which is statement I. It also assumes that the project's capital structure (debt to value ratio) will remain consistent with the firm's overall capital structure, which is statement II. However, statement III is not always true as the cash flows from a project may have a finite life rather than being a perpetuity.

When Using the Weighted Average Cost of Capital (WACC) to Discount