Question

Duvall Inc. uses only equity capital and has two equally sized divisions. Division A’s cost of capital is 10%. Division B’s cost of capital is 14%. The WACC is 12%. All of Division A’s projects are equally risky, as are all of Division B’s projects. However, the projects of Division A are less risky than those of Division B. Which of the following would the company accept?

		Division B project with a return of 13%
		Division B project with a return of 12%
		Division A project with a return of 11%
		Division A project with a return of 9%

Answer 1

Answer: Division A project with a return of 11%

To be profitable, the project should have return higher than the cost of capital at that division.

Division B project with a return of 13%. The cost of capital at B is 14%, more than the return on project and hence it is not profitable.

Division B project with a return of 12%. The cost of capital at B is 14%, more than the return on project and hence it is not profitable.

Division A project with a return of 11%. The cost of capital at A is 10%, less than the return on project and hence it is profitable.

Division A project with a return of 9%. The cost of capital at A is 10%, more than the return on project and hence it is not profitable.