# Swizer Industries has two separate divisions. Division X has less risk so its projects are...

## Question:

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 0.45 and a tax rate of 35 percent. The cost of equity is 14.7 percent and the after-tax 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?

## Divisional Cost of Capital

The divisional cost of capital can be greater or lesser than the weighted average cost of capital of a company depending on the riskiness of the division's projects. The division should accept projects which meet the required rate of return on a given project.

Given the above information about Swizer Industries, we can calculate the weighted average cost of capital (WACC).

{eq}WACC = W_d*K_d*(1-T)+W_e*K_e {/eq}

{eq}WACC = (0.45/1.45)(0.051)+(1/1.45)(0.1470) {/eq}

{eq}WACC = 11.72\% {/eq}

 WACC Division X Division Y 11.72% 11.72%+0.5%=11.22% 11.72%+1%=12.72%

Since Division X provides a rate of return of 11.64% which is greater than the required rate of return of 11.22%, therefore, in case of Division X, the new project yields positive NPV and adds value to the company. While Division Y provides a rate of return of 12.30% which is less than the required rate of return of 12.72%, therefore, the new project does not yield value to the company.

Thus, the company should accept Division X's project while rejecting Division Y's project. 