Suppose a firm uses a corporate-wide WACC in a multi-divisional firm. Which of t

Question

Suppose a firm uses a corporate-wide WACC in a multi-divisional firm. Which of the following statement(s) is (are) incorrect: 1. The use of a corporate-wide cost of capital could lead to the rejection of some projects in the less risky divisions. 2. The use of a corporate-wide cost of capital would allocate too much capital to the less risky divisions. 3. The use of a corporate-wide cost of capital would allocate too much capital to the riskier divisions. 4. Multi-divisional companies should use a common corporate-wide hurdle rate.

Explanation / Answer

3. The use of a corporate-wide cost of capital would allocate too much capital to the riskier divisions.

4. Multi-divisional companies should use a common corporate-wide hurdle rate.

These statements are incorrect. The use of a corporate-wide cost of capital would allocate too much capital to the less risky divisions and not riskier divisions as the corporate-wide cost of capital would be lower than the rate of riskier divisions therefore it would allocate too much capital to the riskier divisions.

Multi-divisional companies should use a common corporate-wide hurdle rate because multi-divisional companies should use different hurdle rate for each and every division.

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