A diversified company has decided to use its overall firm WACC as a performance benchmark for rating its divisional managers and to decide whether new projects from its three divisions should be funded for investment capital. The firm WACC is 10%. The divisional WACCs for its high risk, average risk, and low risk divisions are 16%, 10%, and 8%, respectively. Please explain: (a) What will happen to the firm's overall risk and market value if the firm WACC (10%) is used to evaluate projects and managers of high risk division; (b) What will happen to the firm's overall risk and market value if the firm WACC (10%) is used to evaluate projects and managers of low risk division; and (c) How would managers of high-risk and low-risk divisions react to using firm WACC as a performance benchmark for managers and divisional investment projects.
A diversified company has decided to use its overall firm WACC as a performance benchmark for rating its divisional managers and to decide whether new projects from its three divisions should be funded for investment capital. The firm WACC is 10%. The divisional WACCs for its high risk, average risk, and low risk divisions are 16%, 10%, and 8%, respectively. Please explain: (a) What will happen to the firm's overall risk and market value if the firm WACC (10%) is used to evaluate projects and managers of high risk division; (b) What will happen to the firm's overall risk and market value if the firm WACC (10%) is used to evaluate projects and managers of low risk division; and (c) How would managers of high-risk and low-risk divisions react to using firm WACC as a performance benchmark for managers and divisional investment projects.
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