Question

1. Which one of the following is the primary determinant of the cost of capital for a project?

   	I.	the sources of a firm’s current financing
   	II.	the use of the project’s funds
   	III.	the sources where a firm gets its outside financing
   	IV.	the actual source of funds used for the project

1. M&M Proposition I, without taxes, advocates that:

   	I.	a firm’s WACC decreases as the firm’s use of leverage increases.
   	II.	the level of a firm’s financial risk is determined by the firm’s return on assets.
   	III.	it is completely irrelevant how a firm arranges its finances.
   	IV.	the cost of equity increases as the firm’s use of leverage increases.

Answer 1

Question 1 ) Use of the Project's funds

The primary determinant of the cost of the capital of a project is how the company use the project funds.If the company uses the funds in risky project the firm will need to discount this risk to arrive at the net cash flows and if the project is less risky then the firm may need to discount at lower rate to arrive at present value of cash flows.

Question 2 ) Option 3 is the correct answer

According to the M&M proposition 1, It is completely irrelevant how the firm arranges it's finances because in this proposition it is assumed that the markets are perfectly efficient, so there is no taxes and bankruptcy cost, so, if the firm is Managedd by debt, it would not be able to take any tax benefits and the value of company is calculated by discounting the future cash flows to arrive at present value of cash flows.