Divisional Cost of Capital: A Study of Its Use by Major U.S. Firms

The study examines the use of divisional cost of capital by Fortune 1000 companies. Two hundred and ninety eight firms (29.8 percent) responded to the survey. While the concept of weighted average cost of capital is utilized by 85.2 percent of the respondents, less than 50 percent use divisional cost of capital. By using a single firm cut-off criterion for all projects, there is the potential for intrafirm misallocation of capital since projects initiated by high risk divisions are more likely to be accepted because of high returns. Lower return divisions with less risk may be starved for capital when only a single weighted average cost of capital is used. The author also suggests some normative approaches to solve the problem.