Question

7. Factors that affect the cost of capital equation 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: Acme Manufacturing Corporation 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 Acme Manufacturing Corporation 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.

Answer 1

1st part:

A.interest rates in the economy

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

Interest rates in the economy and performance of index funds are outside the firms control.

The firm's capital structure is within the control of the firm.

2nd part

Reject the proposal.

3rd part:

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

(H's required return is 14% and the project is returning 12%).