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When financing a new project by raising capital, in which of the following situations will a company most likely increase the value of its firm?
- A. The value of the firm will increase when the return from the project is
positive. - B. The value of the firm will increase only when the weighted average cost
of capital (WACC) is greater than the return on the project. - C. The value of the firm will increase only when the return on the project
is greater than the weighted average cost of capital (WACC).
- A. The value of the firm will increase when the return from the project is
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The correct answer is C.
The WACC is considered as an opportunity cost for the firm. Therefore, a company can create value by producing returns that are greater than the cost of capital (WACC).
Options B and C are incorrect because taking on projects whose returns are below the WACC will decrease the value of the firm. For example, a one-year project that would return 1% when the cost of capital is 10% would decrease the value of the firm.
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