To determine the appropriate cost of capital to use when calculating the value of a firm, you should discount the project cash flows

Question

Quizplus · Accepted Answer

The appropriate cost of capital to use when calculating the value of a firm is the weighted average cost of capital of the firm, which takes into account both the cost of equity and the cost of debt. Discounting project cash flows at the firm's cost of equity or at the firm's cost of debt alone would not reflect the overall cost of capital for the firm. Discounting project cash flows at the equity premium is also not appropriate as it does not reflect the specific cost of capital for the firm. Therefore, B is the best answer. The cost of capital used to calculate the value of a firm should be the weighted average of the cost of debt and cost of equity, as this reflects the overall cost of funds for the firm. This takes into account both the return required by equity investors as well as the interest payments due to debt holders. Therefore, the best choice is to discount the project cash flows at the weighted average cost of capital of the firm.

To Determine the Appropriate Cost of Capital to Use When