7. Factors that affect the WACC equation Aa Aa Each of the following factors aff

Question

7. Factors that affect the WACC equation Aa Aa 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 The effect of the tax rate on the cost of debt in the weighted average cost of capital equation 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? O Reject the project O Accept the project On what grounds do you base your accept-reject decision? O Division H's project should be accepted, as its return is greater than the risk-based cost of capital for the division O Division H's project should be rejected since its return is less than the risk-based cost of capital for the division

Explanation / Answer

1st question:

A.The general level of stock prices.

B.The effect of the tax rate on the cost of debt in the weighted average cost of capital equation.

The general level of prices and tax rates are outside a firm's control.

The firm's capital structure is within a firms control.

2nd question

A.reject the project

(explanation in 3rd answer)

3rd question

B.Division H's project should be rejected, as its return is lesser than the risk based cost of capital for the divsion.

(the actual division cost of capital is 14%, whereas the project returns only 12%).

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