31
3
.
Risk-adjusted cost of capital
Answer: c
Diff: M
By Kemp not making the risk adjustment, it is true that the company will accept more projects in the computer division,
and fewer projects in the restaurant division.
However, this will make the company riskier overall, raising its cost of equity.
Investors will discount their cash flows at a higher rate, and the company’s value will fall.
In addition, some of the
computer projects might not exceed the appropriate risk-adjusted hurdle rate, and will actually be negative NPV projects,
further destroying value. Therefore, statement a is false.
Because fewer of the restaurant projects will be accepted, the
restaurant division will become a smaller part of the overall company.
Therefore, statement b is false.
As explained above,
statement c is true.
32
3
.
Risk-adjusted cost of capital
Answer: b
Diff: M
By not risk adjusting the cost of capital, the firm will tend to reject low-risk projects since their returns will be lower than
the average cost of capital, and it will take on high-risk projects since their returns will be higher than the average cost of

capital.
33
3
.
Risk-adjusted cost of capital
Answer: e
Diff: M
34
3
.
Risk-adjusted cost of capital
Answer: a
Diff: M
35
3
.
Division WACCs and risk
Answer: e
Diff: M
If the company uses the 10 percent WACC, it will turn down all projects with a return of less than 10 percent but more than
8 percent.
Thus, these “safer” projects will no longer be taken, and the company will increase the proportion of risky
projects it undertakes.
Therefore, statement a is true.
If Division A’s projects have lower returns than Division B’s because
they have less risk, fewer and fewer projects will be accepted from Division A and more projects will be accepted from
Division B.
Therefore, Division B will grow and Division A will shrink. Therefore, statement b is true.
If the company
becomes riskier, then its cost of equity will increase causing WACC to increase.
Therefore, statement c is true.
Because all
of the statements are true, the correct choice is statement e.
36
3
.
Divisional risk and project selection
Answer: e
Diff: M
N
The correct answer is statement e.
Statement a is correct; the firms have the same size and capital structure, so the WACC
of the merged company is just a simple average of their separate WACCs.
Statement b is correct; Project X has an IRR of
10.5% and its appropriate cost of capital is 10%, therefore, the project has a positive net present value.
Statement c is also
correct; Project X should be accepted because of the previous argument.
Project Y should be rejected because it has an
11.5% return and its appropriate cost of capital is 12%.
Therefore, statement e is the correct choice.
37
3
.
Beta and project risk
Answer: a
Diff: M
38

3
.
Miscellaneous concepts
Answer: a
Diff: M
39
3
.
Cost of new equity
Answer: b
Diff: E
k
e
=
+ 5% = 9.94%.

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- Cost Of Capital, Interest, Dividend yield, Weighted average cost of capital, a. b. c.