Fundamentals of Sustainability Accounting (FSA) Credential Level 2 Practice Exam

The statement "cost of capital impacts will almost always be reflected in an adjustment to the discount rate" emphasizes the relationship between risk and expected returns in the context of investment. When a company is perceived to be managing risk poorly, investors typically demand a higher return to compensate for that increased level of risk. This necessitates an adjustment to the discount rate used in valuation models, reflecting the heightened expectation of returns due to the associated risks.

Higher perceived risk translates to a need for a higher return, reinforcing the principle that investors adjust their expectations based on how well a company manages risk. Thus, if risk management is inadequate, investors expect a return that compensates for the increased risks taken with their capital, making it necessary for companies to target higher return rates in such circumstances. This underscores the fundamental finance principle that the cost of capital is crucial in shaping investor expectations and ultimately influences investment decisions.