Divisional Cost of Capital

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: How to Estimate a Project Specific Discount Rate

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
Your next lesson will play in 10 seconds
  • 0:02 Cost of Capital
  • 1:36 Divisional Cost
  • 3:04 Lesson Summary
Save Save Save

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Log in or Sign up

Speed Speed
Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

How does a company know if an investment in the expansion of a specific division is a good idea? In this lesson, we'll examine the divisional cost of capital and how it can help business leaders make informed decisions about spending money for a segment of their business.

Cost of Capital

Carlos runs a company that offers cleaning services to commercial buildings, and also makes cleaning products that sell in stores. They have two major divisions: their consumer products division, in charge of the cleaning products, and their commercial services division, in charge of the commercial cleaning services.

Carlos wants to invest in a new, big marketing and advertising campaign for the consumer products. He really wants to get the word out that their products are great, but the campaign will cost his company money. Is it worth it?

What Carlos is facing is not unusual. It costs money to expand a business or start new projects. The cost of capital is an estimate of what investing in an asset or product will return versus what it would return if the money was invested in a different asset. In other words, it is an estimate of the minimum a project will have to return in order for it to be a good investment.

Companies often focus on what the company as a whole has to earn in order to determine the risk and feasibility of a project or expansion. But what if a company wants to take on a riskier, or less risky, project or expansion, one that might bring in more or less than the cost of capital says the company needs to bring in? And what if the project that a company wants to invest in only involves a specific part of the company?

That's the problem Carlos is dealing with now. When deciding about the advertising campaign, should he look at the cost of capital for the entire company, or just for the consumer products division? To help Carlos make that decision, let's explore the divisional cost of capital.

Divisional Cost

Carlos wants to invest in an advertising campaign for his company's consumer products division, but in making a final decision, he doesn't know whether to look at the risk and capital of his entire company, or just the consumer products division.

The risk of a specific division, which may be higher or lower than that of the company as a whole, should guide the decision-making about projects undertaken within that division. For example, Carlos' consumer products division might be riskier than their commercial services division, and therefore riskier than the company as a whole. If that's the case, it is the riskier data of the consumer products division that should influence Carlos' decision-making process.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 200 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create an account