Reference no: EM133050796

Question - VACC Ltd is a provider of computer software and information technology services and has two divisions operating in different regions in Southeast Asia. The company uses the market rate of return (rm) as 10.5 to evaluate investments; however, based on recent management reports, it realized that the two divisions have quite different risk and return profiles. In fact, Division 1 has equity betas of 2.0, while for Division 2, it is about 1.25. The financial manager aims to estimate the cost of capital as precisely as possible and evaluate how acceptable investments in both divisions are at an 11 percent rate.

The following data is available for both divisions:

	Division 1	Division 2
Equity beta	2.0	1.25
Tax rate	25%	30%
Cost of debt	7%	9%
Debt ratio	35	45
Risk-free rate of interest RF	4.5
Market risk premium	6

REQUIRED -

1. Estimate the weighted average cost of capital (WACC) for both divisions.

2. Briefly explain how acceptable an investment at an 11 percent rate of return would be when you consider the cost of capital for each Division.

3. Assume VACC Ltd estimates a 13 percent return for the current financial period. Do you think both Divisions will provide potential benefits to the company based on this return? Explain your view.