8. Factors that affect the WACC equation Aa Aa Each of the following factors aff

Question

8. Factors that affect the WACC equation Aa Aa 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 firm's capital budgeting decision rules Interest rates in the economy The performance of index funds, such as the S&P; 500 The impact of cost of capital on managerial decisions Consider the following case: Edinburgh Exports 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 His considering a project with an expected return of 12%. Should Edinburgh Exports accept or reject the project? O Reject the project O Accept the project On what grounds do you base your accept-reject decision? O Division H's project should be rejected since its return is less than the risk-based cost of capital for the Division H's project should be accepted, as its return is greater than the risk-based cost of capital for the division

Explanation / Answer

1st part.

The following factors are outside a firms control:

Interest rates in the economy.

The performance of index funds.

(interest rates are decided by regulators based on liquidity requirements in the economy, performance of index funds is dependent on macro economic factors).

2nd part.

a. Reject the project.

(since the division's WACC is 14% and the projects return is only 12%, Edingburgh exports should reject the project).

b.Division H's project should be rejected since its return is less than the risk based cost of capital for the division.

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