- CFA Exams
- CFA Level I Exam
- Topic 3. Corporate Issuers
- Learning Module 5. Capital Investments and Capital Allocation
- Subject 3. Capital Allocation Principles and Pitfalls
CFA Practice Question
The opportunity cost of capital for a risky project is the expected rate of return on a ______.
B. well-diversified portfolio of common stocks.
C. portfolio of securities with similar risk to that of the project
A. government security with the same maturity as the project.
B. well-diversified portfolio of common stocks.
C. portfolio of securities with similar risk to that of the project
Correct Answer: C
User Contributed Comments 8
| User | Comment |
|---|---|
| niti | why should alternate investment be of same risk? |
| mtcfa | Becasue of the required rate of return (i.e. the discount rate, which investors require for a given level of risk), and therefore managers must choose from among projects with the same risk level. You must compare apples to apples. |
| sarath | The alternative investment should be of the same risk otherwise it will not be a meaningful comparison... |
| Rotigga | Of course the difficult part in the real world is quantifying risk ... |
| moneyguy | More risk, more reward! Except when you lose... |
| Inaganti6 | in the real world how can you define risk or quantify two projects as having same risk...... if you were the CEO of a coal mining company how can you possibly tell if it's better to invest $1 billion on an undeveloped mine or whether it's better to acquire a $1 billion stake in an existing operation |
| CIDan | Obviously it's impossible to know exactly what your risk is, but you can assume decision maker is rational with investment knowledge. The decision maker could use a binomial model to then estimate risk based on the estimated probability of certain outcomes. |
| ctate | C is not correct, it is the return from the best alternative use of cash/resources used. There is no specfication as to whether that alternative use has to have a similar risk outlook |