Question

What are the challenges of estimating cost of capital for a project taken by a division in a multi-divisional firm, such as Disney, that do not exist when estimating cost of capital of the firm itself (here, Disney)? How would you deal with these challenges (at least discuss two such challenges)

Answer 1

Challenges for estimating cost of capital for project undertaken by division in a multidivisional form is that cost of capital of the entire company is different and the cost of capital of particular division is different so so it is is highly complex in estimation of cost of capital.

This is because the divisional cost of capital is not specifically calculated while the company's cost of capital are specifically calculated, but in such cases when there is a particular project which is undertaken by the division and it is specifically for the use of the division, the specific cost of capital which must be risk weighted according to different type of capital financing structure used by the division, must be adopted in order to have a better picture of acceptability of the project.

the problems which are related to estimation of cost of capital would be to a particular division is diversifying.for example if Disney is entering into an another business which is currently not been done by the company it cannot use the weighted average cost of capital of its earlier projects which are into other industry.

in such cases it is always prudent to use either project based weighted average cost of capital or divisional based weighted average cost of capital in order to enhance the efficiency and acceptability of a better project.