Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. 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 projects should the firm accept?

Question

Quizplus · Accepted Answer

The firm should accept the Division A project with an 11% return because it has a lower cost of capital and the projects are less risky. This project will have a higher net present value (NPV) than the Division B projects, even though they have a higher return. The firm should always choose projects with the highest NPV, which is a function of both the project return and the project risk.

Duval Inc Uses Only Equity Capital, and It Has Two Equally-Sized