Computing the divisional cost of capital using the pure play method

Authors

H. W. Collier, University of WollongongFollow
T. Grai, Oakland University, USA
S. Haslitt, Oakland University, USA
C. B. McGowan, Norfolk State University, USAFollow

RIS ID

29097

Publication Details

This is a preprint of an article accepted for publication as Collier, HW, Grai, T, Haslitt, S and McGowan, CB, Computing the divisional cost of capital using the pure play method, Applied Financial Economics Journal, 2006(in press). Copyright Taylor and Francis. Original journal available here.

Abstract

The Cost of Capital Model is used to calculate the net present value of projects within a multi-unit corporation but may provide incorrect answers for projects that have a level of risk that differs from the overall average risk level for the corporation. We demonstrate the use of the Pure Play Method for calculating the required rate of return for a division of a corporation that has risk characteristics that differ from the risk characteristics of the overall corporation. We apply this methodology to the Integrated Electronic Systems Segment of the Motorola Corporation. We find that the IESS division cost of capital of is 9.3% rather than the 12.3% cost of capital for the corporation as a whole.