medium · Principles of Finance cost-of-capital-structure
If an analyst uses the consolidated company's levered beta of 1.1 for a new division that has a pure-play unlevered beta of 1.5, what is the effect on the estimated WACC?
- The WACC stays accurate as long as the parent firm's D/E ratio is applied consistently here.
- The WACC will be underestimated, potentially leading to 'empire building' through bad acquisitions.
- The WACC will be overestimated, causing the firm to systematically pass on high-return projects.
- The cost of debt will automatically decrease enough to fully offset the incorrect equity beta being used.
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