Each of the following factors affects the weighted average c

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 firm\'s dividend payout ratio The effect of the tax rate on the cost of debt in the weighted average cost of capital equation The impact of cost of capital on managerial decisions Consider the following case Marston Manufacturing Company 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 Marston Manufacturing Company accept or reject the project? Accept the project O Reject the project On what grounds do you base your accept-reject decision? Division H\'s project should be accepted, as its return is greater than the risk-based cost of capital for the division. Division H\'s project should be rejected since its return is less than the risk-based cost of capital for the division.

Solution

1: General level of stock prices

(Firm cannot control the prices in economy. It can decide the dividend payout based on policies and profits. It can also control the tax impact by deciding the amount of debt in capital)

2: Reject

(Since the risks are different, the cost of capital for individual division will be considered. Hence cost is 14% which is higher than the return of 12%)

3: Division H’s project should be rejected as its return is less than the risk based cost ofcapital

(Since the risks are different, the cost of capital for individual division will be considered. Hence cost is 14% which is higher than the return of 12%)