The company cost of capital may be an inappropriate discount rate for a capital budgeting proposal if:

Question

Quizplus · Accepted Answer

The company cost of capital is the weighted average of the cost of debt and equity and is used to discount cash flows in capital budgeting proposals. However, if the risk of the proposal is different from the overall risk of the company, then the cost of capital may not be an appropriate discount rate. In such a case, a different discount rate that reflects the specific risk of the proposal should be used. Therefore, option B is the best choice. Option A is incorrect because NPV is an output of the capital budgeting analysis, not a basis for selecting a discount rate. Option C may be true, but it is not the best choice since it is too general and does not specifically address the appropriateness of the cost of capital. Option D is also not the best choice since expecting to earn more than the risk-free rate is a normal expectation for any investment, and it does not explain why the cost of capital may be inappropriate for a specific proposal.

The Company Cost of Capital May Be an Inappropriate Discount