McCue Company has equal amounts of low-risk, average-risk, and high-risk projects. McCue estimates that its overall WACC is 13%. The CFO believes that this is the correct WACC for the company’s average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees on the grounds that, even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO’s position is accepted, what is likely to happen over time?
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The company will take on too many high-risk projects and reject too many low-risk projects.
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The CFO’s recommendation will maximize the firm’s intrinsic value.
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The firm’s overall risk should decrease over time.
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The company’s overall WACC should decrease over time because its stock price should be increasing.
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