International Exchange has three divisions: A, B, and C. Division A has the leas

Question

International Exchange has three divisions: A, B, and C. Division A has the least risk and Division C has the most risk. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 35 percent debt and 65 percent equity. Division A's projects are assigned a discount rate that is 3 percent less than the firm's weighted average cost of capital. What is the discount rate applicable to Division A?

7.98 percent

8.27 percent

8.44 percent

9.48 percent

13.43 percent

Explanation / Answer

WACC = rD (1- Tc )*( D / V )+ rE *( E / V )

1.    Rd(1-Tc) = Tax adjusted cost of debt=6.1%

2.    (D/V) = (Debt/Total Value)= .35

3.    rE= the firm's cost of equity= 14.3%

4.    (E/V) = (Equity/Total Value)= .65

WACC= 6.1*.35 + 14.3*.65= 11.43%

Discount rate applicable to Division A= 11.43 – 3= 8.43%

Option C 8.44%

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