Certified Management Accountant Practice Exam

The correct answer is rooted in the concept of the hurdle rate, which represents the minimum return that an investment must generate to be considered worthwhile. It is often derived based on the expected risk associated with a project or investment.

Assuming that all projects have the same risk level is a common pitfall because different projects can entail varying degrees of risk, which should affect the hurdle rate used for each investment. For example, a high-risk project should have a higher hurdle rate compared to a low-risk project to account for the additional uncertainty and potential for loss associated with it. Failing to accurately reflect the risk profile can lead to misinformed decision-making, as a project with a lower risk may appear less attractive when compared to one with higher risk if both are held to the same hurdle rate.

On the other hand, while using the average market return as the hurdle rate, adjusting the hurdle rate for all risk types equally, and utilizing future cash flows for current assessments can present various challenges, they do not directly pertain to the fundamental misconception of treating all projects as equally risky. Each of these choices may involve different strategic missteps, but they do not capture the essence of the risk assessment error highlighted by assuming uniform risk across diverse projects.