Question

Next Page Page 13 of 25 Question 13 (6 points) Which of the following statements about discount rates is true? The longer the time period over which a transaction will generate cash flows, the higher the discount rate should be. The greater the amount of cash generated by a transaction, the higher the discount rate should be. The higher the degree of risk involved in a transaction, the higher the discount rate for future cash flows should be. The higher the marginal tax rate, the higher the discount rate for future cash flows should be. Page 13 of 25 Next Page 11 FVO B FB ने FO 9 x FS & 7 8 % 5 6 $ 4 * U 3 Y T

Answer 1

Generally the investors are risk averse as they dont want to risk their investmnet to any loss . So if there is higher degree of risk involved in a transaction the higher the discount rate(which is required rate of return) should be higher for future cash flows should be . This results in lower present value of the cash flow. As with the rising risk the cost of capital also increases and to compensate that a higher discount rate is required to compare whetehr we should invest in it or not if the present value is less than upfront cost then the investment is rejected