Suppose your firm has decided to use a divisional WACC approach to analyze proje

Question

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.8, 1.0, 1.5, and 1.7, respectively. Assume all current and future projects will be financed with half debt and half equity, the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 7 percent) is 12 percent and the after-tax yield on the company’s bonds is 8 percent. What will the WACCs be for each division?

Explanation / Answer

The expected rate of return on the market can be solved by:

            Now can solve for the divisional costs of equity using the average divisional betas:

                        Finally, we can solve for the divisional WACC:

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