All of the following statements are correct except:
A) Relevant cash flows are incremental before-tax cash flows, which must be discounted using an incremental after-tax cost of capital.
B) The firm's relevant cost of capital is computed from after-tax financing costs.
C) A project's incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project, that is, the cost of raising one additional dollar of capital.
D) In estimating the cost of capital, the firm's analysts need to evaluate investors' expected returns under likely market conditions and then use these expected returns to compute the firm's marginal future cost of raising funds.

Question

Quizplus · Accepted Answer

Relevant cash flows are indeed incremental and before-tax, but they are discounted using an after-tax cost of capital, not an incremental after-tax cost of capital. The distinction is that the cost of capital used for discounting should reflect the overall cost to the firm of raising capital, not just the incremental cost associated with a specific project.

All of the Following Statements Are Correct Except