Question

Duvall Inc. uses only equity capital and has two equally sized divisions. Division A’s cost of...

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%

Homework Answers

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.

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