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ACCA Strategic Professional · Advanced Financial Management · International investment and financing decisions

Which statement best describes why a multinational should normally use a project-specific discount rate rather than its group weighted average cost of capital (WACC) for an overseas investment?

A project-specific rate is needed because the overseas project's business risk and financing capacity may differ from the group's existing operations. Group WACC is valid only when project risk and gearing match the group, so otherwise it can accept poor projects or reject good ones.

  1. AThe project's business risk and financing capacity may differ from those of the existing group, so the group WACC may misstate the required returnCorrect
  2. BThe group WACC always understates the cost of equity in overseas markets because of exchange rate movements
  3. COverseas projects are always financed entirely by local debt, so the WACC has no relevance
  4. DTax rates abroad make the cost of equity independent of systematic risk

Explanation

WACC is appropriate only when the project has the same business risk and the same financial risk as the existing company and is marginal in size. An overseas project often differs in systematic risk and debt capacity, so a rate reflecting the project's own risk is needed. The other options make absolute claims that are not true.

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