Give an Example of a Situation Where a Firm Should

question 30

Essay

Give an example of a situation where a firm should adopt the pure play approach for determining the cost of capital for a project.
A. The example should explain why the WACC of Firm B, which is engaged in the type of operations Firm A is considering, should be used as the basis for setting the discount rate for the proposed project.

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Definitions:

NPV Decision Rules

Guidelines used to determine the viability of an investment or project based on the Net Present Value, which calculates the present value of cash inflows minus the present value of cash outflows.

Shareholder Wealth

The total value of a company to its shareholders, typically measured by the market capitalization or the equity value of the company.

Cost of Capital

The necessary yield a business must secure on its ventures to sustain its valuation in the marketplace and raise capital.

Cost of Equity

The return that investors require for their investment in a company, essentially the amount a firm must pay to retain its equity investors.