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Which of the following statements is least accurate regarding the marginal cost of capital’s role in determining the net present value (NPV) of a project?

A)
Projects for which the present value of the after-tax cash inflows is greater than the present value of the after-tax cash outflows should be undertaken by the firm.

B)
The NPVs of potential projects of above-average risk should be calculated using the marginal cost of capital for the firm.

C)
When using a firm’s marginal cost of capital to evaluate a specific project, there is an implicit assumption that the capital structure of the firm will remain at the target capital structure over the life of the project.

The WACC is the appropriate discount rate for projects that have approximately the same level of risk as the firm’s existing projects. This is because the component costs of capital used to calculate the firm’s WACC are based on the existing level of firm risk. To evaluate a project with above (the firm’s) average risk, a discount rate greater than the firm’s existing WACC should be used. Projects with below-average risk should be evaluated using a discount rate less than the firm’s WACC. An additional issue to consider when using a firm’s WACC (marginal cost of capital) to evaluate a specific project is that there is an implicit assumption that the capital structure of the firm will remain at the target capital structure over the life of the project. These complexities aside, we can still conclude that the NPVs of potential projects of firm-average risk should be calculated using the marginal cost of capital for the firm. Projects for which the present value of the after-tax cash inflows is greater than the present value of the after-tax cash outflows should be undertaken by the firm.

Which of the following statements about the role of the marginal cost of capital in determining the net present value of a project is most accurate? The marginal cost of capital should be used to discount the cash flows:

A)	for potential projects that have a level of risk near that of the firm’s average project.

B)	of all projects the firm is considering.

C)	if the firm’s capital structure is expected to change during the project’s life.

Net present values of projects with the average risk for the firm should be determined using the firm’s marginal cost of capital. The discount rate should be adjusted for projects with above-average or below-average risk. Using the marginal cost of capital assumes the firm’s capital structure does not change over the life of the project.