Which of the Following Is a Limitation to the Weighted

question 30

Multiple Choice

Which of the following is a limitation to the Weighted Average Cost of Capital approach?

• A) Later projects may be rejected as not meeting the hurdle rate because cheaper funding was used up on an earlier project.
• B) Capital structures and interest rates are highly dynamic, always creating inconsistency in determining an overall cost of capital.
• C) The approach assumes that there will be more than one form of capital in the structure thereby being inapplicable to companies funded solely by common shares.
• D) Different investment decisions have different levels of risk and this is not taken into account in the model.
• E) An insufficient number of companies use this method of evaluating their capital structure to trust in its reliability.

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Definitions:

Profitability Index

A measure used in capital budgeting to evaluate the profitability of an investment, calculated as the present value of future cash flows divided by the initial investment cost.

Discount Rate

The interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve's discount window.