4. Duval Inc. uses only equity capital, and it has two equally-sized divisions.

Question

4. Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?

a. A Division B project with a 13% return.

b. A Division B project with a 12% return.

c. A Division A project with an 11% return.

d. A Division A project with a 9% return.

e. A Division B project with an 11% return.

EXPLAIN ANSWER AND SHOW WORK

Explanation / Answer

Since projects of Division A are less risky than those of Division B, the firm should choose Division B's projects only if the retun from division B exceeds its cost.

In the option (a), (b) and (e) return from Division B is 13%, 12% and 11% respectively which is lower than its cost i.e. 14%, thus option (a) should not be choosen.

However if project A's return exceeds its cost than it can be choosen.

In option (c) project A's return is 11% which exceeds its cost i.e, 10%

Therefore option (c) will be a better option. Thus option (c) should be choosen

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