Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of the following factors are outside a firm’s control? Check all that apply. Interest rates in the economy The performance of index funds, such as the S&P 500 The firm’s capital structure The impact of cost of capital on managerial decisions Consider the following case: Edinburgh Exports has two divisions, L and H. Division L is the company’s low-risk division and would have a weighted average cost of capital of 8% if it was operated as an independent company. Division H is the company’s high-risk division and would have a weighted average cost of capital of 14% if it was operated as an independent company. Because the two divisions are the same size, the company has a composite weighted average cost of capital of 11%. Division H is considering a project with an expected return of 12%. Should Edinburgh Exports accept or reject the project? Reject the project Accept the project On what grounds do you base your accept–reject decision? Division H’s project should be rejected since its return is less than the risk-based cost of capital for the division. Division H’s project should be accepted, as its return is greater than the risk-based cost of capital for the division.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter3: Evaluation Of Financial Performance

Section: Chapter Questions

Problem 10P

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Question

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of the following factors are outside a firm’s control? Check all that apply.

Interest rates in the economy

The performance of index funds, such as the S&P 500

The firm’s capital structure

The impact of cost of capital on managerial decisions

Consider the following case:

Edinburgh Exports has two divisions, L and H. Division L is the company’s low-risk division and would have a weighted average cost of capital of 8% if it was operated as an independent company. Division H is the company’s high-risk division and would have a weighted average cost of capital of 14% if it was operated as an independent company. Because the two divisions are the same size, the company has a composite weighted average cost of capital of 11%. Division H is considering a project with an expected return of 12%.

Should Edinburgh Exports accept or reject the project?

Reject the project

Accept the project

On what grounds do you base your accept–reject decision?

Division H’s project should be rejected since its return is less than the risk-based cost of capital for the division.

Division H’s project should be accepted, as its return is greater than the risk-based cost of capital for the division.

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