Well, what about non-conglomerate firms?
Is this likely to be a problem for
firms that invest in the same type of projects time and time again?
Well, the good news is that no, this won't be such a problem for
firms that conduct their business in a very focused area of operations.
And the reason's pretty obvious.
The average risk of the assets in place drives the weighted average cost of
capital, which also matches the systematic risk of the assets in place,
such that the hurdle rate suggested by WACC
would be expected to be very similar to the hurdle rates suggested by
formal asset pricing models such as the capital asset pricing model.
Okay. Is that all there is to it?
Well, unfortunately not.
There's another fly in the ointment, so to speak.
Earlier, we interpreted the result that firms use a company-wide discount rate as
being evidence that they use WACC as their hurdle rate.
In fact there's some quite recent evidence that this might not actually be the case.
Ravi Jagannathan, David Matsa, Iwan Meier, and
Vefa Tarhan surveyed 4600 CFOs of US listed firms, and they asked
these CFOs what discount rate they used as a hurdle rate in the previous two years.