World Corporation has traditionally employed a firm-wide discount rate for capital budgeting purposes. However, its two divisions - publishing and entertainment - have different degrees of risk given by βP = 1.1, βE = 1.8, while the beta for the overall firm is 1.3. The publishing division has proposed three projects with these internal rates of return: P1 = 13.2 percent; P2 = 12.4 percent; and P3 = 9.8 percent. The entertainment division has presented their three projects: E1 = 16.4 percent; E2 = 17.8 percent; and E3 = 14.7 percent. The risk-free rate is 4 percent and the market risk premium is 8 percent.
a. Identify which projects will be accepted if the firm applies its overall beta to all projects.
b. Then identify which projects will be accepted if the division betas are properly applied.
c. Explain the likely reasons for the three betas having differing values.