Download Cost of Capital Corporations often use different costs of capital for

Cost of Capital
Corporations often use different costs of capital for different operating divisions. Using an
example, calculate the weighted cost of capital (WACC). What are some potential issues in using
varying techniques for cost of capital for different divisions? If the overall company weighted
average cost of capital (WACC) were used as the hurdle rate for all divisions, would more
conservative or riskier divisions get a greater share of capital? Explain your reasoning. What are
two techniques that you could use to develop a rough estimate for each division’s cost of capital?
Your initial response should be 200 to 250 words.
Knowing where a business stands when they want to seek growth in their assets they need to
ensure that their current/present financial assets will support this new step.
Weighted average Cost of capital also known as (WACC) requires returns after-tax. Bonds and
other types of debt is tax deductible with this it does lower the effective cost of debt to the firm.
Other things that are added to this are firm’s bond, preferred stock, and common equity this is
all weighted by the proportional contribution (Hickman, Byrd, & McPherson, 2013).
(A) Targeted
Proportion
(B) Project
Capital
Component
Debt (bonds)
Or Weight
35.0%
Cost
$72,328
(A)x(B)
Dollars
raised
$25,315
Preferred Stock
8.9%
$72,328
Common
Equity
56.1%
$72,328
100.0%
(D) After-tax
required
returns
7.3%
(A)x(D)
weighted
average
2.56%
$6437.00
13.4%
1.19%
$40,576
17.00%
9.54%
$72,328
13.29%
In this chart above it is noted that the cost of the particular project is $72,328 and the weighted
average would be 13.44%. With estimating the discount rate it is not always the correct or best
discount rate fo the company and this will be reflected and create risk. If the project is riskier
than the hurdle rate should be higher but any company that would want to invest in something
without a lot of risk would have riskier divisions with greater share of capital. To get a rough
estimate one could use a substitute for the division also calculating the discount rate.
Hickman, K. A., Byrd, J. W., & McPherson, M. (2013). Essentials of finance. San Diego, CA:
Bridgepoint Education Inc.