Question

Which of the following is false?

The cost of capital:

a) is determined by the source of the fund.

b) is an opportunity cost that depends on the use of the funds, not the source.

c) is the same thing as the required rate of return.

d) is the same as the WACC for projects with equal risk to the firm as a whole.

Answer 1

Option (a)

EXPLANATION for each Option

a) FALSE : Cost of Capital is basically determined by the fact that where such Money will get Invested. So if such money will be Invested in Very Risky Projects then the Provider of Finance would demand MORE and Vice-versa. So its Independent of Source of Fund.

b) TRUE : As just discussed in part (a), Cost of Capital is an Opportunity Cost for the Providers of Finance because they are losing some other Investment Opportunity when they are Investing into a particular Company.

c) TRUE : Cost of Capital is basically termed from the Borrower's point of view WHEREAS same is known as Required Rate of Return from the Lender's point of view.

d) TRUE : WACC is basically Overall Cost of Capital for the Firm WHEREAS Cost of Capital can be of Individual Projects/Divisions. But when the OVERALL RISK IS SAME of Both FIRM and INDIVIDUAL PROJECT then WACC = COST OF CAPITAL.

But it will vary when the Risk between the two is not same.