Using the weighted cost of capital as a cutoff rate assumes that the riskiness of the project being evaluated is similar to the riskiness of the company's existing assets.

Question

Quizplus · Accepted Answer

The weighted cost of capital (WACC) takes into account the riskiness of a company's existing assets, as well as the cost of financing those assets through debt and equity. Therefore, using the WACC as a cutoff rate for evaluating a new project assumes that the riskiness of the project is similar to the company's existing assets. This is because the WACC represents the required rate of return that investors expect for the company overall, given its mix of debt and equity financing and the risk associated with those sources of capital.

Using the Weighted Cost of Capital as a Cutoff Rate