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CS Executive · Corporate Accounting and Financial Management · Cost of Capital

In financial management, the cost of capital used as the cut-off rate for accepting a new project is best described as:

Cost of capital is the minimum return a project must earn so that the market value of the firm's equity stays unchanged. It acts as the hurdle or cut-off rate for investment decisions, because projects earning less would reduce shareholder wealth.

  1. AThe minimum rate of return a project must earn to keep the market value of the firm's equity unchangedCorrect
  2. BThe maximum rate of interest a bank may charge on a term loan
  3. CThe average dividend declared by the firm over the last five years
  4. DThe coupon rate printed on the firm's oldest debenture

Explanation

Cost of capital is the minimum required return on investments so that the value of the firm and the wealth of shareholders are not reduced. It is therefore the cut-off or hurdle rate for projects. The other options describe a lender's rate, a historical dividend, or a coupon, none of which is a required-return benchmark.

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