Question

Jeff Bezos has just promoted you to Chief Financial Officer of Amazon. You find on your desk plans for Amazon’s latest project: to corner the paper clip market by buying the world’s largest paper clip manufacturing company. Your financial analysts have determined that this project will be a lot less risky than any of Amazon’s other current operations, since paper clips will probably continue to be used at the current level well into the foreseeable future. Amazon’s overall WACC is 10%. Which of the following would be a reasonable course of action to take?

• Take 3 percentage points off the company’s overall WACC, since this project is less risky than Amazon’s overall operations

• Use 10% as the project’s WACC, since risk does not play a role in WACC

• Add 3 percentage points to the company’s overall WACC, because lower risk would lead to a higher WACC

• Use an average of pure-play paper clip companys' WACC's as a proxy for this project’s WACC

• Both A and D are reasonable courses of action for you to take

Answer 1

Option E. Both A and D are reasonable courses of action for you to take

The reason behind such reduction in WACC is that the project is less risky and when the project is less risky the probability of losing is less so we have expect lesser return from project as this project is less risky than amazon's overall operations. Use an average of pure-play paper clip companys' WACC's as a proxy for this project’s WACC is also another available option

Option B is incorrect because risk plays pivotal role in WACC calculation

Option C is incorrect because risk is less in this project so we won't add % points to wacc

Please dont forget to upvote