7. Factors that affect the cost of capital equation

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of the following factors are outside a firms control? Check all that apply.

Interest rates in the economy

The performance of index funds, such as the S&P 500

The firms dividend payout ratio

The impact of a firms cost of capital on managerial decisions

Consider the following case:

National Petroleum Refiners Corporation (NPR) has two divisions, L and H. Division L is the companys 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 companys 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 L is considering a project with an expected return of 9.5%.

Should National Petroleum Refiners Corporation (NPR) accept or reject the project?

Accept the project

Reject the project

On what grounds do you base your acceptreject decision?

Division Ls project should be accepted, because its return is less than the risk-based cost of capital for the division.

Division Ls project should be accepted, since its return is greater than the risk-based cost of capital for the division.