Ajax Corp. has been operating as three separate divisions over the past ten years, although all capital budgeting decisions are ultimately made at the home oﬃce using the ﬁrm's overall WACC.
Just recently, they discovered the divisions have signiﬁcantly different risks. Which of the following
Is also likely to be true?

Question

Quizplus · Accepted Answer

If the low earning division maintains lower levels of risk, it is likely that it is being ignored in the capital allocation process despite the differences in risk among the divisions. This indicates a potential problem with using the overall WACC for all divisions without considering their individual risk profiles. A more appropriate approach would be to use a division-specific cost of capital that reflects the risk of each division. Option A is incorrect because it assumes that decreasing risk is rewarded, which is not stated in the question. Option B is incorrect as higher earnings do not necessarily correlate with lower risk. Option D is incorrect as the differences in risk should have an impact on the capital budgeting process. Option E is also incorrect as the highest divisional cost of capital will depend on the specific risk profile of the division and may not necessarily equal the overall cost of capital.

Ajax Corp Has Been Operating as Three Separate Divisions Over the the Past