Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 2 divisions, A and B, with betas for each division of 0.5 and 1.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 5%) is 14% and the after-tax yield on the company's bonds is 6%, what are the WACCs for divisions A and B?
A) 7.75%; 12.25%
B) 8.75%; 12.00%
C) 9.25%; 11.00%
D) 8.95%; 10.15%

Question

Quizplus · Accepted Answer

WACC for division A = (0.5 x 5% x (1 - 35%)) + (0.5 x 14% x 0.5) = 2.375% + 3.5% = 7.875%

WACC for division B = (0.5 x 6%) + (0.5 x 14% x 1.5) = 3% + 10.5% = 13.5%

Therefore, the answer is A, with division A having a WACC of 7.875% and division B having a WACC of 13.5%.

Suppose Your Firm Has Decided to Use a Divisional WACC