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 dividend payout ratio
The impact of cost of capital on managerial decisions
Consider the following case:
Wellington Industries 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 Wellington Industries accept or reject the project?
Reject the project
Accept the project
On what grounds do you base your accept–reject decision?
Division H’s project should be rejected since its return is less than the risk-based cost of capital for the division.
Division H’s project should be accepted, as its return is greater than the risk-based cost of capital for the division.
The factors outside control are:
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
Reject the project
Division H’s project should be rejected since its return is less than the risk-based cost of capital for the division.
Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of...