PRIN.OF CORPORATE FINANCE
PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 9, Problem 18PS

Fudge factors John Barleycorn estimates his firm’s after-tax WACC at only 8%. Nevertheless, he sets a 15% companywide discount rate to offset the optimistic biases of project sponsors and to impose “discipline” on the capital budgeting process. Suppose Mr. Barleycorn is correct about the project sponsors, who are, in fact, optimistic by 7% on average. Explain why the increase in the discount rate from 8% to 15% will not offset the bias.

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