Question

If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely a. accept too many low-risk projects and too few high-risk projects. b. become riskier over time, but its intrinsic value will be maximized. c. become less risky over time, and this will maximize its intrinsic value. d. continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital. e. become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

Answer 1

Answer: statement E

Explanation: The correct answer for this case would be "become more risky and also have an increasing WACC . Its intrinsic value will not be maximized. WACC is the cost of capital at a given point in time at average risk of the company. To evaluate different projects for different level of risks we shave to adjust WACC as per the level of risk. Thus same WACC for different level of projects will result in high risk of failure of projects but the real value of company will never increase .