Fussy Inc.is composed of two different divisions: food catering and shoe making.The company's overall WACC is 10%, while the WACC for the food catering division is 9% and for the shoe making division is 12%.What would happen if the company used the overall WACC in the valuation of the following independent projects?

Question

Quizplus · Accepted Answer

If the company uses the overall WACC in the valuation of the projects, it implies that they are considering only one rate of return for all the projects. However, this is not appropriate when the company has two different divisions, each with its own WACC.

Using the overall WACC would lead to incorrect project valuation and ranking, as it does not account for the difference in risk between the two divisions.

In this case, project I belongs to the food catering division, which has a lower WACC than the overall company WACC. Therefore, it would be incorrectly rejected if the overall WACC is used.

Project III belongs to the shoe making division, which has a higher WACC than the overall company WACC. Therefore, it would be incorrectly accepted if the overall WACC is used.

Project II belongs to an independent company, and its WACC is not provided. Therefore, it cannot be determined whether it would be correctly or incorrectly accepted if the overall company WACC is used.

Project IV belongs to the food catering division, which has a lower WACC than the overall company WACC. Therefore, it would be incorrectly rejected if the overall WACC is used.

Therefore, choice C is the best option as it correctly identifies the projects that would be incorrectly rejected or accepted if the company used the overall WACC in their valuation.

Fussy IncIs Composed of Two Different Divisions: Food Catering and Shoe