The McCue Company Has Equal Amounts of Low-Risk,average-Risk,and High-Risk Projects

question 83

Multiple Choice

The McCue Company has equal amounts of low-risk,average-risk,and high-risk projects.McCue estimates that its overall WACC is 12%.The CFO believes that this is the correct WACC for the company's average-risk projects,but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects.The CEO disagrees on the grounds that,even though projects have different risks,the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources.If the CEO's position is accepted,what is likely to happen over time?

• A)The company will take on too many high-risk projects and reject too many low-risk projects.
• B)The company will take on too many low-risk projects and reject too many high-risk projects.
• C)Things will generally even out over time, and therefore the firm's risk should remain constant over time.
• D)The company's overall WACC should decrease over time because its stock price should be increasing.

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Definitions:

EURO

The official currency of the Eurozone, which is used by 19 of the 27 European Union countries.

Official Currency

The legally established money within a country that is used as a medium of exchange, store of value, and unit of account.

GDP

Gross Domestic Product, the total value of all goods and services produced within a country in a given period, a primary indicator of economic health.

GATT Agreement

The General Agreement on Tariffs and Trade; a legal agreement between many countries whose overall purpose was to promote international trade by reducing or eliminating trade barriers such as tariffs or quotas.