Assertion (A) : Weighted average cost of capital should be used as a hurdle rate for accepting or rejecting a capital budgeting proposal. Reason (R) : It is because by financing in the proportions specified and accepting the project, yielding more than the weighted average required return, the firm is able to increase the market price of its stock. Codes :
Both (A) and (R) are true.
Assertion: the weighted average cost of capital (WACC) is the overall minimum return the firm must earn on its investments to satisfy all suppliers of funds. When a project carries the same risk as the firm and is financed in the firm’s target proportions, WACC is the right hurdle (cut-off) rate for accepting or rejecting it. The Assertion is true.
Reason: if the firm finances in the specified proportions and accepts a project whose return exceeds the weighted average required return, the surplus over the cost of funds accrues to equity shareholders, raising the value of the firm and the market price of its shares (Van Horne). This is the logic behind using WACC as the hurdle rate, so the Reason is true.
The codes given do not offer a separate choice on whether the Reason explains the Assertion; the relevant judgement is that both statements are correct.
Hence, Both (A) and (R) are true.
Similar Questions
A company has issued 10 percent perpetual debt of ₹ 1 lac at 5 percent premium. If tax rate is 30 percent, then the cost of debt will be :
Indicate the cost of equity capital, based on capital asset pricing model, with the following information :
Beta coefficient – 1.40
Risk-free rate of interest – 9%
Expected Rate of Return on equity in the market – 16%
Match the items of the following two lists and suggest the correct code :
List – I List – II a. Realised yield method i. Cost of equity share capital b. Taxation ii. Cost of equity capital c. Cost of total capital employed iii. Cost of debt capital d. Dividend growth is a consideration iv. Weighted cost of capital Codes :
a b c d
From investor’s point of view, the cost of capital is :
Important Questions from Cost of Capital
A company has 10% perpetual debt of Rs. 1,00,000. The tax rate is 35%. Which one of the following is the after-tax cost of capital assuming that the debt is issued at 10% premium?
Company's current price of share is Rs. 60 and dividend per share is Rs. 4 . If its capitalisation rate is 12 percents. What is dividend growth rate?
X Ltd. forfeited 40 shares of Rs. 10 each and on which Rs. 4 per share were paid. If the forfeited shares reissued as Rs. 8 per share paid up, what is the minimum price the company must charge?
Which of the sources of finance has an implicit cost of capital?
Cost of Equity Share Capital is more than cost of Debt because :
