What is the main factor considered when evaluating the risk of a project?

When evaluating the risk of a project, the firm's cost of capital plays a pivotal role as it reflects the required returns expected by investors for providing capital to the firm. The cost of capital serves as a benchmark against which the project's expected returns are compared, helping to assess whether the project is worth the investment and the associated risk.

This is essential because a project's riskiness affects the rate of return that investors demand. If a project is perceived to carry a higher level of risk, the firm will need to offer a higher return in order to attract investment. Conversely, a project that is deemed less risky would typically be associated with a lower required return. Thus, the cost of capital is not only a measure of the risk associated with financing but also a critical element in determining whether the project meets the required return threshold to be considered viable and worth pursuing.

Understanding the cost of capital allows decision-makers to evaluate potential investments more effectively and make informed choices that align with the firm's overall financial strategy.