I am thinking of doing the same in our small bath and I do not think it would be a no-no. But, we will see what people say.
Out of curiousity, what type of beadboard wainscotting are you using? One contractor I spoke with said that you do not want to use MDF b/c it is not water resistant, so that would leave wood and the wood might stick out too far and make my small bathroom even smaller. Just something to think about. I found a vinyl solution, but am not sold on using that either.

Funny I was just about to buy the MDF for my small bathroom, but now you have saved me. However, can't you waterseal the MDF?

I would not recomend it. when you renovate any area of your home, it should match the rest of the house. otherwise it can hurt the resale value

What style is the rest of your home - it can work if it has a traditional feel.

thanks for the comments, we have ended up not doing the wainscotting because i found a tile for the bath that i really liked and it was the right price. i still do like the wainscotting and really like the photo above...maybe next house.

I did exactly what you are describing in my small powder room and it looks great. Got lots of compliments. I'm actually planning to add the bead board in the hallway too.