Swizer Industries has two separate divisions. Division X has less risk so its projects are assigned a discount rate equal to the firm's WACC minus 0.5 percent. Division Y has more risk and its projects are assigned a rate equal to the firm's WACC plus 1 percent. The company has a debt-equity ratio of .45 and a tax rate of 35 percent. The cost of equity is 14.7 percent and the aftertax cost of debt is 5.1 percent. Presently, each division is considering a new project. Division Y's project provides a 12.3 percent rate of return and division X's project provides an 11.64 percent return. Which projects, if any, should the company accept?

Question

Quizplus · Accepted Answer

To determine which projects should be accepted, we need to compare the required rate of return (discount rate) with the project's rate of return.

For Division X: 
Discount Rate = WACC - 0.5% = 14.7% - 0.5% = 14.2%
Project Return = 11.64%

Since the project's return (11.64%) is less than the required rate of return (14.2%), Division X's project should be rejected.

For Division Y: 
Discount Rate = WACC + 1% = 14.7% + 1% = 15.7%
Project Return = 12.3%

Since the project's return (12.3%) is greater than the required rate of return (15.7%), Division Y's project should also be rejected.

Therefore, the best choice is to accept X and reject Y, making answer B the correct choice.

Swizer Industries Has Two Separate Divisions