With respect to issues related to the cost of capital:

Question

Quizplus · Accepted Answer

The WACC (weighted average cost of capital) is the correct discount rate for average-risk projects. It takes into account the cost of both debt and equity financing and is used to discount a project's cash flows to determine its net present value.

Answer: D 
 The expected return on equity is relevant to capital budgeting decisions because it represents the required return that equity holders will demand based on the risk of the project. Projects with higher risk will require higher expected returns on equity to compensate for that risk, which can impact the project's profitability and potential for acceptance.

A and B are incorrect statements. 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, not before tax, to satisfy security holders.

With Respect to Issues Related to the Cost of Capital