Question

which of the following discount rates will most likely over - discount short - term cash flows?
○ wacc
○ prime interest rate
○ 90 - day treasury - bill yield
○ line of credit interest rate

Explanation:

1. Understand Discounting and Rates: Discounting short - term cash flows requires a rate that reflects the appropriate cost of capital or opportunity cost for the short term.

• WACC (Weighted Average Cost of Capital) is a long - term average cost of capital that combines the cost of debt and equity. It is designed for evaluating long - term projects as it considers the capital structure over the long run. When used for short - term cash flows, since it is a long - term rate, it will tend to over - discount (i.e., reduce the present value too much) short - term cash flows because short - term cash flows are less exposed to the long - term risks and costs that WACC accounts for.
• The prime interest rate is the rate that banks charge their most credit - worthy customers. It is more of a reference rate for loans and not specifically designed for discounting short - term cash flows in a way that would over - discount them compared to WACC.
• The 90 - day Treasury - bill yield is a short - term risk - free rate. It is appropriate for discounting short - term cash flows as it reflects the short - term opportunity cost of capital (investing in risk - free short - term government securities). So it will not over - discount short - term cash flows.
• The line of credit interest rate is the rate charged for a line of credit, which is a form of short - term borrowing. It is related to the cost of short - term debt but is not a rate that is used to over - discount short - term cash flows in the same way as WACC. It is more about the cost of borrowing for short - term funds rather than a discount rate for valuing cash flows.

Answer:

A. WACC