Computing the divisional cost of capital using the pure-play method

Henry Collier, Timothy Grai, Steve Haslitt and Carl McGowan

Applied Financial Economics, 2007, vol. 17, issue 15, 1227-1231

Abstract: The cost of capital model is used to calculate the net present value (NPV) 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 (IESS) 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.

Date: 2007
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DOI: 10.1080/09603100600970065

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