Question

A firm's WACC: A) Is the proper discount rate for every project the firm undertakes B)...

A firm's WACC:

A) Is the proper discount rate for every project the firm undertakes

B) Is used to value all of the firm's existing projects

C) Is a benchmark discount rate that is adjusted for the riskines of each project

D) Is an informational value only and should never be used as a discount rate

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Answer #1

C) Is a benchmark discount rate that is adjusted for the riskines of each project

WACC is weighted average cost of capital for the firm in which each category of capital is proportionately weighted. This WACC also is a risk indicator. Higher WACC signals higher risk and vice-versa. This WACC is used as a discount rate as well, when assessing the firm's cashflows

This firm's WACC, however, cannot be directly used to assess the cashflows associated with projects that company wants to undertake. Every prject will have it own set of risk as well as a capital structure plan, and the firm's WACC should be adjusted to appropriately display the associated risk with the project. Higher risk project should have cashflows discounted by a WACC + Risk premium during assessment.

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