Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely
A) become less risky over time, and this will maximize its intrinsic value.
B) accept too many low-risk projects and too few high-risk projects.
C) become more risky and also have an increasing wacc. its intrinsic value will not be maximized.
D) continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.
E) become riskier over time, but its intrinsic value will be maximized.

Question

Quizplus · Accepted Answer

Low-risk projects will tend to have low expected returns and vice versa for high-risk projects due to competition in the economy. By not adjusting the cost of capital for project risk, the firm will tend to reject low-risk projects even though they earn higher returns than their risk-adjusted costs of capital, and vice versa for high-risk projects. As the firm takes on more high-risk projects, its true WACC will increase over time. Of course, the true WACC might change over time due to changes in market conditions, but that could cause the true WACC to either rise or decline. Therefore, statement c is correct.

Suppose Acme Industries Correctly Estimates Its WACC at a Given