Problem:
Two managers within a company are discussing capital budgeting projects. Manager 1 heads up Division A with average projects that are fairly safe and considered low risk. Division A's cost of capital is 10%. Manager 2 heads up Division B with average projects that are considered high risk.
Division B's cost of capital is 14%. Each division makes up 50% of the firm's revenues and assets. Two projects are being evaluated. Project S is a Division A type project that has an expected return of 11%, while Project R is a Division B type project that has an expected return of 13%. There is enough capital to accept both projects.
Acceptance of either or both projects doesn't change the firm's target capital structure. Manager 1 believes that Project S should be accepted and Project R should be rejected. Manager 2 believes that Project R should be accepted and Project S should be rejected.
Based on the concepts learned in this unit, discuss which project(s) should be accepted and explain your reasoning. Include in your discussion the concept of the firm's composite cost of capital (include a calculation for this firm) and the ramifications to the firm if the wrong project(s) is accepted.