Final answer:
Correcting an overestimated opportunity cost of capital to a lower value would likely increase the project's internal rate of return (IRR). This is because the cash flows are discounted at a lower rate, which may make the project more attractive as the gap between the project's return and the cost of capital widens.
Step-by-step explanation:
If the opportunity cost of capital is overestimated, correcting this error to reflect a lower cost of capital would affect the project's internal rate of return (IRR). The IRR is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. Specifically, if the opportunity cost of capital is lowered, the difference between the project's return and the cost of capital increases, which could potentially make a previously unattractive project attractive, as the expected returns become more favorable when evaluated against a lower discount rate.
A financial investor, when deciding what future payments are worth in the present, uses an interest rate reflecting the opportunity cost of investing financial capital, including a risk premium if applicable. For example, if the appropriate interest rate to value future payments is considered to be 15%, and this rate is incorrectly estimated as higher, correcting the error to 15% would mean that the project's cash flows are discounted at a lower rate, potentially raising the project's IRR. The IRR is calculated independently from the cost of capital, but the project's acceptability is determined by comparing the IRR to the opportunity cost of capital. In this case, a lower cost of capital might result in the project being accepted if the IRR is now greater than the revised, lower cost of capital.