The managers of Corn Co. use the firm\'s weighted average cost of capital (WACC)
ID: 2802934 • Letter: T
Question
The managers of Corn Co. use the firm's weighted average cost of capital (WACC) as the required return for projects similar to those of the firm's existing operations. For projects of higher risk, they use a rate equal to WACC plus 2 percent. For projects of lower risk, they subtract 2 percent from the WACC. Which approach is the firm using to determine the required return for a project?
beta adjustment
subjective
systematic
pure play
Answer is Subjective!
beta adjustment
subjective
systematic
pure play
Explanation / Answer
Ans. As the answer here is mentioned subjective because here depending on lower and higher risk 2% risk is subtracted or added to WACC to factor the additional or lower risk involved in the new projects are clearly different from the risk involved with the firm as a whole.
To quantify it as a 2% risk is very subjective in nature as there is not much evidence or data given to actually quantify that additional risk involved with new projects that will be undertaken by the firm.
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