17 Galaxy Systems, Inc. As the three division managers of Galaxy systems, Inc. entered the central headquarters meeting room each felt under pressure. They were there to meet with Marlene Davidson, the senior vice president of finance. Marlene, a CPA who had spent seven years with Ernst and Young before being recruited by Galaxy Systems, was a strong believer in implementing the latest techniques in corporate financial management. She maintained that there should not be one figure for cost of capital that was uniformly applied throughout the corporation. Although the current figure of 12 percent was well documented, she intended to propose that different types of investments utilize different discount rates. Her first inclination was to suggest that the nature of the project be the controlling factor in determining the discount rate. The riskier the project the higher the discount rate required. For example, repair to old machinery might carry a discount rate of six percent; a new product, 12 percent; and investments in foreign markets, 20 percent. This was a well accepted method that she had used a number of times while on consulting assignments at Emst and Young. When she discussed this approach with Joe Halstead, the CEO of Galaxy Systems, he said the risk-adjusted discount rate made a lot of sense to him. He went on to say that management as well as stockholders tend to be risk averse and, therefore, higher risk projects should meet tougher return standards. However, in the case of Galaxy Systems, Mr. Halstead suggested they consider a slightly different approach. He maintained that his company was made up of three distinctly different businesses and that each business should have its own imputed rate to be used as its discount rate. The three divisions were a) the airline parts manufacturing division; b) the auto airbags production division, and c) the aerospace division. The latter division built modern missile and control systems and jet fighter planes under contract with the defense department of the U.S. government. Mr. Halstead maintained that each division had a risk dimension that was uniquely its own. He asked Marlene Davidson about a strategy to measure risk exposure for each division. She suggested that there were two major approaches to do this. A. Find comparable public companies in each industry the division was in and look up their betas. The higher the average beta for a given industry, the more risk the comparable companies in that industry had. Divisions that were in industries with high average betas would have higher required rates of return