A company uses its company-wide cost of capital to evaluate new capital investments. What is the implication of this policy when the company has multiple operating divisions, each having unique risk attributes and capital costs?

a. Low-risk divisions will over-invest in low-risk projects.

b. Low-risk divisions will over-invest in new projects and high risk divisions will under-invest in new projects.

c. High-risk divisions will over-invest in new projects and low risk divisions will under-invest in new projects.

d. High-risk divisions will under-invest in high-risk projects.

答案：C

Explanation

Choice "c" is correct. A company-wide cost of capital averages risks to arrive at required return for investments. The company-wide cost of capital will be lower than the cost of capital specific to high-risk projects and higher than the cost-of-capital specific to low-risk projects. If a company is comprised of multiple divisions with unique risk characteristics, higher risk divisions will automatically beat the threshold for investments and invest in higher risk projects that beat the company wide average. Meanwhile, their lower risk counterparts will find it hard to achieve the risk return that beats the average (artificially inflated) returns that are driven by higher risk divisions and will under invest in new projects.

Choice "d" is incorrect. A company-wide cost of capital averages risks to arrive at a required return for investments. The company-wide cost of capital will be lower than the cost of capital specific to high-risk projects and higher than the cost-of-capital specific to low-risk projects. If a company is comprised of multiple divisions with unique risk characteristics, higher risk divisions will automatically beat the threshold for investments and invest in higher risk projects that beat the company wide average.

Choice "a" is incorrect. A company-wide cost of capital averages risks to arrive at required return for investments. The company-wide cost of capital will be lower than the cost of capital specific to high-risk projects and higher than the cost-of-capital specific to low-risk projects. If a company is comprised of multiple divisions with unique risk characteristics, lower risk divisions will find it hard to achieve the risk return that beats the average (artificially inflated) returns that are driven by higher risk divisions and thereby under invest in new projects.

Choice "b" is incorrect. A company-wide cost of capital averages risks to arrive at required return for investments. The company-wide cost of capital will be lower than the cost of capital specific to high-risk projects and higher than the cost-of-capital specific to low-risk projects. If a company is comprised of multiple divisions with unique risk characteristics, higher risk divisions will automatically beat the threshold for investments and invest in more, not less, higher risk projects that beat the company wide average. Meanwhile, their lower risk counterparts will find it hard to achieve the risk return that beats the average (artificially inflated) returns that are driven by higher risk divisions and thereby invest less and not more new projects.