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

Which statement about the significance of cost of capital is correct?

Cost of capital is used as the discount rate when evaluating investment proposals, such as in NPV, and as the hurdle rate for IRR. It also guides capital structure decisions and serves as a performance benchmark, so it is not a profit margin.

  1. AIt is used to evaluate investment proposals, for example as the discount rate in NPVCorrect
  2. BIt is relevant only for dividend accounting and not for capital structure decisions
  3. CIt is irrelevant for assessing the performance of a firm
  4. DIt is always equal to the firm's accounting profit margin

Explanation

Cost of capital serves as the discount rate for NPV and the hurdle rate for IRR, guides capital structure choices by identifying the mix that minimises the overall cost, and acts as a benchmark for performance. The other statements deny these roles or confuse it with a profit margin.

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