Smith and Jones Has Two Separate Divisions

question 50

Multiple Choice

Smith and Jones has two separate divisions.Division X produces custom work on a pre-paid basis only for long-term customers and therefore,is subject to less risk than division Y.The company has assigned a discount rate equal to the firm's WACC minus 2 per cent to division X and a rate equal to the firm's WACC plus 3 per cent to division Y.The company has a debt-equity ratio of 0.65 and a tax rate of 35 per cent.The cost of equity is 9 per cent and the after tax cost of debt is 5 per cent.Presently,each division is considering a new project.Division Y's project provides a 9.5 per cent rate of return and division X's project provides a 6.2 per cent return.Which projects,if either,should the company accept? Assume a classical tax system.

• A)accept X and reject Y
• B)accept both X and Y
• C)reject both X and Y
• D)the answer cannot be determined without additional information
• E)reject X and accept Y

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