24) Acme Conglomerate Corporation operates three divisions. One division involve

Question

24) Acme Conglomerate Corporation operates three divisions. One division involves significant research and development, and thus has a high-risk cost of capital of 15%. The second division operates in business segments related to Acme's core business, and this division has a cost of capital of 10% based upon its risk. Acme's core business is the least risky segment, with a cost of capital of 8%. The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This approach will

a) favor projects in the core business division because that division is the least risky.
b) favor projects in the research and development division because the higher risk projects look more favorable if a lower cost of capital is used to evaluate them.
c) not favor any division over the other because they all use the same company-wide weighted average cost of capital.
d) favor projects in the related businesses division because the cost of capital for this division is the closest to the firm's weighted average cost of capital.

Explanation / Answer

Acme Conglomate operates three divisions. One division involves significant research and development, and thus has a high risk cost of capital of 15% The second division operates in business segmeivision is the closest to the firm's weighted cost of capital related to Acme's core business, and this division has a cost of capital of 10% based upon its risk. Acme's core business is least risky segment, with a cost capital of 8%. The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This approach is:


b. favor projects in the research and development division bec. the higher risk project loook more favorable if lower cost of capital is used to evaluate them.

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