When using CAPM to determine a benchmark return against which to compare a project's IRR, you should
A)use the yield on a three-month Treasury security as your risk-free rate.
B)use the yield on a Treasury security that most closely matches the duration of your project as your risk-free rate.
C)use the yield on a ten-year Treasury security as your risk-free rate.
D)use the yield on a one-year Treasury security as your risk-free rate.

Question

Quizplus · Accepted Answer

The risk-free rate used in CAPM should be a representative of a long-term, default-free investment that matches the duration of the project. Since the project may last for several years, using a short-term Treasury security like a three-month or one-year may not be an accurate representation of the risk-free rate. Using a ten-year Treasury security may also not be appropriate if the project has a shorter duration. Therefore, the yield on a Treasury security that most closely matches the duration of the project should be used. Choice B is the best option. Using a Treasury security that most closely matches the duration of your project as the risk-free rate takes into account the specific timing of the project's cash flows and therefore provides a more accurate benchmark return for comparison. The three-month Treasury security may be too short-term and the ten-year Treasury security may be too long-term, whereas the security with a duration closest to the project's duration is more appropriate.

When Using CAPM to Determine a Benchmark Return Against Which