CAF-7 · Chapter 9 · Question 11 of 15
If a company decides to issue new shares to finance a highly risky project (one that completely alters the business's overall risk profile), why should it NOT use its existing Weighted Average Cost of Capital (WACC) to appraise the project?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) Because the existing WACC reflects the risk of the company's current operations, not the new higher-risk project
Explanation
A company's current WACC represents its current risk profile. If a new project significantly changes the business risk (which changes the equity Beta), the existing WACC becomes invalid, and a new project-specific discount rate must be calculated.
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