9. Factors that affect the WACC 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.

The firm's capital structure

Interest rates in the economy

The firm 's dividend payout ratio

The general level of stock prices

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?

Reject the project

Accept the project

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

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

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