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What happens if we use the WACC for the discount rate for all projects?

What happens if we use the WACC for the discount rate for all projects?

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Expert Solution

If we use the WACC for discount rate for all the projects then we may accept projects that we should not have accepted or we may reject projects we should have accepted.

The discount rate should be based on the riskiness of the project. Higher the riskiness of the project higher should be the discount rate. Suppose if we use WACC for the discount rate, which is lower than the discount rate required for this risky project, then the NPV may be positive and we may accept this project. If we used a higher discount rate, the NPV would turn negative and not accepting the project would be the right decision.

Similarly, a lower discount rate should be used for projects that are relatively less risky. If we use WACC for the discount rate, which is higher than the discount rate required for this less risky project, then the NPV may be negative and we may reject this project. If we used a lower discount rate, the NPV would turn positive and accepting the project would be the right decision.

jeff jeffy answered 1 year ago
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