Why Should Firms That Own and Operate Multiple Businesses That

question 91

Multiple Choice

Why should firms that own and operate multiple businesses that have different risk characteristics use business-specific,or divisional costs of capital?

• A) Not all divisions have equal risk and the firm might accept projects whose returns are higher than are deemed appropriate.
• B) Not all business divisions have equal risk and the firm will likely become less risky in the future.
• C) Not all lines of business have equal risk and it is likely that the firm will accept projects whose returns are unacceptably low in relation to the risk involved.
• D) Use of the same weighted average cost of capital for all divisions may result in too much money being allocated to the least risky division.

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Definitions:

Forward Contract

A financial derivative contract between two parties to buy or sell an asset at a predetermined future date for a price that is agreed upon today.

Contingent Liability

A potential financial obligation that depends on a future event arising from past transactions or events.

Probable

In financial and legal contexts, a high likelihood that an event will occur, often used in reference to the realization of assets or the incurrence of liabilities.

Reasonably Estimated

A valuation or measurement that can be calculated with a reasonable level of accuracy, often applied in accounting for provisions and contingencies.