If a Firm Uses Its WACC as the Discount Rate

question 80

Multiple Choice

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to:
I.reject some positive net present value projects.
II.accept some negative net present value projects.
III.favor high risk projects over low risk projects.
IV.increase its overall level of risk over time.

• A)I and III only
• B)III and IV only
• C)I, II, and III only
• D)I, II, and IV only
• E)I, II, III, and IV

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Definitions:

Operating Leverage

A measure of how revenue growth translates into growth in operating income, showing the proportion of fixed to variable costs.

Fixed Costs

Overheads, such as rent, insurance fees, and payroll, that stay the same, independent of the amount of goods produced or sold.

Sensitivity Analysis

An analysis method to evaluate how changes in the values of an independent variable influence a dependent variable, based on a set of given assumptions.

NPV

Stands for Net Present Value, a method used in capital budgeting to evaluate the profitability of an investment or project.