9. Factors that affect the cost of capital equation

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

Interest rates in the economy

The firms capital structure

The firms capital budgeting decision rules

The general level of stock prices

The impact of a firms cost of capital on managerial decisions

Consider the following case:

Lancashire Railway Company (LRC) 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 Lancashire Railway Company (LRC) 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.