Question

A company uses its company-wide cost of capital to evaluate new capital investments. What is the implication of this policy when the company has multiple operating divisions, each having unique risk attributes and capital costs

Answer 1

Answer:

The use of a company‐wide cost of capital to evaluate new capital investments will not result in low‐risk divisions over‐investing in new projects and high‐risk divisions under‐investing in new projects, rather high‐risk divisions will over‐invest in new projects and low‐risk divisions will under‐invest in new projects.