From the list below, select all of the conditions which are required to be true for...
From the list below, select all of the conditions which are required to be true for the tax-adjusted weighted average cost of capital to be strictly accurate and correct for project valuation.
- The tax used to adjust the WACC reflects the firm's marginal tax rate for the project.
- The firm has no other projects to consider.
- The firm must have a significant amount of debt outstanding.
- The firm's capital structure will not change during the life of the project.
- The firm MUST have an effective tax rate of 0%.
- The project is representative of the firm's risk level and is generally similar to what the firm already does.
- The project is very large relative to the firm as a whole.
Homework Answers
The tax used to adjust the WACC reflects the firm's marginal tax rate for the project.- True.
The after tax cost of debt depends on the marginal tax rate
- The firm's capital structure will not change during the life of the project- True
If the capital structure changes during the life of the project, WACC will change , hence the discount rate needs to be changed
- The project is representative of the firm's risk level and is generally similar to what the firm already does.- True
WACC can be used if the risk level is similar to the existing operations. If the risk level of new project changes, the discount rate needs to be adjusted ( increased with higher risk and decreased with lower risk)
Conditions Required to be true:
1.The tax used to adjust the WACC reflects the firm's marginal tax rate for the project.
2.The firm's capital structure will not change during the life of the project.
3. The project is representative of the firm's risk level and is generally similar to what the firm already does.
The following conditions are not required for accurate and correct project valuation:
- The firm has no other projects to consider.- The firm may have number of projects under consideration
- The firm must have a significant amount of debt outstanding.- Not necessary. Firm with low or no debt can also be evaluated by discount rate based on WACC
- The firm MUST have an effective tax rate of 0%.- Not necessary. WACC can be determined accurately and projects evaluated correctly irrespective of the amount of tax rate
- The project is very large relative to the firm as a whole -Not necessary. Evaluation of any size of project can be done accurately by discount rate based on WACC
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