Why It Is Necessary to Make Sure a Project Is

question 236

Multiple Choice

Why it is necessary to make sure a project is in the same risk class as existing operations before using the WACC as the discount rate?

• A) If a project has high risk, then it should be rejected.
• B) A firm that uses its WACC to evaluate projects without regarding the risk class of the project will tend to become riskier over time.
• C) Only projects with similar risk can result in positive NPVs.
• D) If a project is in a different risk class then a different tax rate must be used.
• E) The risk class of a proposed project is important only if it affects the firm's bond ratings.

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Definitions:

Economies of Scale

Cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output generally decreasing with increasing scale.

Average Total Cost

The total cost of production divided by the total quantity of output, representing the cost per unit of output.

Scale of Operations

The scope or size of production, or the level at which a business operates in terms of output.

Average Cost Curve

A graphical representation that shows how the cost per unit of production varies with the quantity produced.