The Green Acres Lawn Company produces and sells lawn care products, such as fertilizers, seeds, and lawnmowers. Its market-beta is 1.30. It is considering diversifying into the manufacture of snowblowers to offset the seasonality of its current product lines. Management has estimated the market-beta for this new line of business to be 1.60. The relevant risk-free rate is 4%, and the market equity risk premium is 7%. Assume that 70% of the business will remain in lawn care products if the firm undertakes this project.
-Refer to the information above. If Green Acres were to require projects coming out of the snowblower division to earn a return based on Green Acres' overall cost of capital, which of
The following would occur?

Question

Quizplus · Accepted Answer

Using the overall cost of capital, which is based on the lower beta of the lawn care business, would result in a lower discount rate than appropriate for the higher-risk snowblower division. This could lead to accepting projects that do not meet the higher risk-adjusted return required for the snowblower division, thus subtracting value from the firm.

The Green Acres Lawn Company Produces and Sells Lawn Care