8. Factors that affect the WACC equation Each of the following factors affects t

Question

8. Factors that affect the WACC equation Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of the following factors are outside a firm's control? Check all that apply. The general level of stock prices The effect of the tax rate on the cost of debt in the weighted average cost of capital equation The firm's capital budgeting decision rules The impact of cost of capital on managerial decisions Consider the following case Marston Manufacturing Company has two divisions, L and H. Division L is the company's low-risk division and would have a weighted average cost of capital of 8% if it was operated as an independent company. Division H is the company's high-risk division and would have a weighted average cost of capital of 14% if it was operated as an independent company. Because the two divisions are the same size, the company has a composite weighted average cost of capital of 11%. Division H is considering a project with an expected return of 12%. Should Marston Manufacturing Company accept or reject the project? O Reject the project Accept the project

Explanation / Answer

Answerr 8 : Level of stock prices as the company can't change the overall market sentiments of other company

Martson

Project should be rejected as the return is lower than the cost of capital for division H

Divisional Cost of Capital;

Cost of capital - real estate division: Rf+beta*(market premium) = 13.65% since firm only uses equity

Similarly for consulting and distribution: 16.33% and 8.29%

Investors should require, we can multiply individual cost of capital to the weightage so it would come out to be 13.78%

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