Q9. Why should firms that own and operate multiple businesses that have differen

Question

Q9. Why should firms that own and operate multiple businesses that have different risk characteristics use business-specific, or divisional costs of capital?
   a. Not all divisions have equal risk and the firm might accept projects whose returns are higher than are deemed appropriate.
   b. Not all business divisions have equal risk and the firm will likely become less risky in the future.
   c. Not all lines of business have equal risk and it is likely that the firm will accept projects whose returns are unacceptably low in relation to the risk involved.
   d. Use of the same weighted average cost of capital for all divisions may result in too much money being allocated to the least risky division.

Explanation / Answer

Risk should always complensate return. Required rate on projects are set based on the riskiness of the projects. If the risk is high, required rate will be set high and if the risk is low, require rate will be set low. If the specific risk adjusted required rate is not used, incorrect decisions will be made.

Hence, correct option is (C).

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