Asked by Laney Ankney on Jun 19, 2024
Verified
A firm has three divisions. A capital budgeting request has just come through for Division C showing a positive NPV at the firm's overall WACC. The financial manager of the firm knows that Division C is the riskiest of the three divisions. The financial manager should:
A) Deny the request since it was computed in error.
B) approve the request since it has a positive NPV
C) Ask that the NPV be recomputed at a cost of capital appropriate for the division.
D) approve the request if neither of the other two divisions have any capital budgeting projects with positive NPVs.
E) Subjectively reduce the NPV to reflect the difference in risk and then accept the project if NPV is still positive.
Capital Budgeting Request
A process in which a business evaluates and plans for future projects or investments, analyzing potential expenses and returns.
Weighted Average Cost of Capital (WACC)
Calculating a business's cost of capital by proportionally weighting each capital variety.
Riskiest Divisions
Business units or segments within a company that are subject to the highest levels of uncertainty and potential loss.
- Comprehend the relationship between a project's level of risk and the rate of return it necessitates.
Verified Answer
AM
aditya mehtaJun 24, 2024
Final Answer :
C
Explanation :
The correct answer is to ask that the NPV be recomputed at a cost of capital appropriate for the division. This is because the overall WACC of the firm may not accurately reflect the risk associated with Division C, which is known to be the riskiest. Using a division-specific cost of capital that reflects its higher risk is a more accurate approach for evaluating the project's viability.
Learning Objectives
- Comprehend the relationship between a project's level of risk and the rate of return it necessitates.