Question

Its 2000, and Bill Gates at Microsoft is contemplating entering the video game market with their brand new Xbox. Mr. Gates wants to use the firms WACC of 12 percent to evaluate the project. Nintendo, a video game company, ahs a WACC of 16 percent. WHat discount rate should Microsoft use toevaluate the new project and Why?

A.10 percent, becaue video games are more fun than software

B. 28 percent, because it reflects both firms WACC

C. 16 percent, because Nintendo is a company taht focuses exclusively on the type of project being considered

D. 12 percent, because it reflects the firms cost of capital and the use of the funds doesnt matter

Answer 1

Overall cost of capital of Microsoft is 12% and cost of capital of Nintendo, a video game company is 16%. Cost of capital of projects depends on risk level of that specific project. Since, risk level of video game market is higher than existing business Microsoft. So, Microsoftuse should use 16 percent WACC, because Nintendo is a company that focuses exclusively on the type of project being considered evaluate the new project .

Option (C) is correct answer.