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. The general level of stock prices O The effect of the tax rate on the cost of debt in the weighted average cost of capital equation The firm's capital budgeting decision rules 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%.

Answer 1

1: reject the project

We will consider the WACC of the division H for this purpose, Since the returns are less than the WACC, this is not profitable.

2: Option 2

The returns are 12% but the cost of capital is14%. Hence the project should be rejected.