Based on your understanding of the concept of cost of capital, which of the foll
ID: 2739445 • Letter: B
Question
Based on your understanding of the concept of cost of capital, which of the following statements are valid? Check all that apply. Companies incorporate the required rate of return in the cost of capital to compensate invectors for the components' risks. Invectors care about the incremental value addition that new projects are making; they are least concerned with the discount rates that the company uses. Companies always use the weighted average cost of capital (WACC) as the discount rate to analyze the financial viability of projects. A company's estimate of cost of capital impacts its application in the analysis of new investments that, consequently, affects the value of the firm and shareholders' wealth.Explanation / Answer
Based on the understanding of the concept of cost of capital, validity / non-validity of the following statements are described below:-
1) Companies incorporate the required rate of return in the cost of capital to compensate investors for the components' risks.
Answer:- This statement is Valid.
Explanation:- Companies incorporate the required rate of return in the cost of capital to compensate investors for the risk they are taking on their individual investment. Required rate of return is from investor's point of view whereas cost of capital is from company point of view.
2) Investors care about the incremental value addition that new projects are making; they are least cocerned with the discount rate that the company uses.
Answer:- This statement is invalid.
Explanation:- Investors are very much concerned with the discount rate that company uses because the discount rate is the basis for the evaluation of the investment project.
3) Companies always uses WACC as the discount rate to analyse the financial viability of projects.
Answer:- This statement is invalid.
Explanation:- It is not necessary that Companies always uses WACC as the discount rate to analyse the financial viability of projects.
4) A company's estimate of cost of capital impact its applications in the analysis of new investments that, consequently, affects the value of firm and shareholders' wealth.
Answer:- This statment is Valid.
Conclusion:- First and Fourth Statement are Valid.