Question

McFann Co. has two divisions, L and H. Division L is the company's low-risk division and would have a WACC of 8% if it were operated as an independent company. Division H is the company's high-risk division and would have a WACC of 14% if it were operated as an independent company. Because the two divisons are the same size, the company has a composite WACC of 11%. Division H is considered a project with an expected return of 12%. Should McFann Co. accept or reject the prject?
A. Accept

B. Reject

On what grounds do you base your accept-reject decision?

A. Division H's project should be accepted, because its return is greater than the risk-based cost of capital for the divison.

B. Division H's project should be rejected, because its return is less than the risk-based cost of capital for the division.

Answer 1

Answer:

B. Reject

B. Division H's project should be rejected, because its return is less than the risk-based cost of capital for the division.

Explanation:

As we can see that the project H Weighted average cost of capital is 14% and the expected rate of return is 12%

So based on this its expected rate of return is less than the cost of capital i.e Weighted average cost of capital

Therefore, the project should be rejected as we compared the Weighted average cost of capital and the expected rate of return