With respect to issues related to the cost of capital:

Question

Quizplus · Accepted Answer

The weighted average cost of capital (WACC) is the appropriate discount rate for average-risk projects as it reflects the expected return demanded by all capital providers (both debt and equity).

Answer: D 
 The expected return on equity is relevant to capital budgeting decisions as it is the minimum return that equity investors expect to earn on their investment in the firm. Therefore, projects with expected returns that are lower than the expected return on equity will likely not be accepted by the firm.

A and B are incorrect. An increase in the debt ratio will result in greater risk for both debt and equity holders, not just debt holders. The cost of capital is the return a firm must earn after-tax to satisfy security holders, not before tax.

With Respect to Issues Related to the Cost of Capital