Which of the following would not be an appropriate guideline for determining the interest rate to use in discounting project cash flows in capital budgeting?
A)For replacement projects, given that their risk is consistent with that of the present business, use the cost of capital.
B)For expansion projects of moderate size, given that their risk is slightly greater than that of the present business, use the cost of capital, plus a small risk premium of one to three percent.
C)For new ventures, given that their risk can be far greater than current operations, use the cost of capital plus a risk premium of at most five percent since using anything higher usually guarantees rejection.
D)All of the above are appropriate guidelines.

Question

Quizplus · Accepted Answer

The guideline suggesting a cap on the risk premium for new ventures at five percent is not appropriate because the risk premium should reflect the actual risk of the project, which could necessitate a higher premium than five percent to accurately account for the increased risk associated with new ventures.

Which of the Following Would Not Be an Appropriate Guideline