Articles

The WACC Fallacy: The Real Effects of Using a Unique Discount Rate

P. KRUEGER, A. LANDIER, D. THESMAR

The Journal of Finance

June 2015, vol. 70, n°3, pp.1253-1285

Departments: Finance

Keywords: Capital budgeting, Cost of capital, Behavioral finance, Investment

http://dx.doi.org/10.2139/ssrn.1764024


In this paper, we test whether firms properly adjust for risk in their capital budgeting decisions. If managers use a single discount rate within firms, we expect that conglomerates underinvest (overinvest) in relatively safe (risky) divisions. We measure division relative risk as the difference between the division's asset beta and a firm-wide beta. We establish a robust and significant positive relationship between division-level investment and division relative risk. Next, we measure the value loss due to this behavior in the context of acquisitions. When the bidder's beta is lower than that of the target, announcement returns are significantly lower


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