A firm has multiple divisions of similar nature, yet varying degrees of risk. Wh

Question

A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?

Assign every project a rate equal to the firm's cost of equity

Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity

Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

Determine the best pure play rate for each project

Assign every project a rate equal to the market rate of return at the time of the proposal

Assign every project a rate equal to the firm's cost of equity

Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity

Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

Determine the best pure play rate for each project

Assign every project a rate equal to the market rate of return at the time of the proposal

Explanation / Answer

Every project is evaluated with required rate of return to evaluate the financial feasibility. While evaluating projects, required rate is set based on the riskiness of the projects. High risk projects will have high required rate and vice-versa.

Hence, correct option is Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment.

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