The opportunity cost of capital for a risky project is:
A)the expected rate of return on a government security having the same maturity as the project.
B)the expected rate of return on a well-diversified portfolio of common stocks.
C)the expected rate of return on a security of similar risk as the project.
D)The expected rate of return on a typical bond portfolio.

Question

Quizplus · Accepted Answer

The opportunity cost of capital for a risky project should be the expected rate of return on a security of similar risk as the project. This is because investors will allocate their capital towards the investment with the highest expected return for the same level of risk. Option A is incorrect since government securities are usually less risky than a risky project and do not reflect the appropriate opportunity cost for the project. Option B is incorrect as a well-diversified portfolio typically has a lower risk than a single risky project and therefore does not reflect the appropriate opportunity cost. Option D is incorrect as a typical bond portfolio would also have a lower risk than a risky project and would not reflect the appropriate opportunity cost.

The Opportunity Cost of Capital for a Risky Project Is