Which of the following statements is true?

Question

Quizplus · Accepted Answer

Undertaking a negative NPV project may increase the value of a firm's equity if it increases the firm's overall risk, which could result in a higher required rate of return on equity and thus a higher cost of equity capital. However, this may decrease the overall value of the firm as the value of debt may decrease due to the increased risk. Therefore, management should consider the impact on the entire firm, not just one part of the capital structure, when making investment decisions. Undertaking a negative NPV project can result in an increase in the value of the firm's equity due to the option value it provides. This option value can potentially increase the value of the firm's equity enough to offset the decrease in overall firm value. However, it is not always the case that undertaking a negative NPV project will result in an increase in equity value and it is ultimately up to management to consider the potential risks and benefits when making investment decisions.

Which of the Following Statements Is True