The weighted average cost of capital measures the average risk inherent in the corporation and overall capital structure of the entire firm. Noting that low asset betas for less cyclical industries such as utilities and household products, versus the much higher asset betas of high-tech firms and luxury retailers, we can’t deal with the varied businesses in the same way when doing the valuation since that different lines of businesses have varied Betas. Meanwhile, Beta, in turn, affects the equity cost of capital and debt cost of capital. In the other hand, even within a firm with a single line of business, some projects obviously have different market risk sensitivity and characteristics form the firm’s other activities.
Using the Marriott’s WACC for valuation only makes sense if the types of investments are consistent with the lines of Marriott’s business. Given that major lines of businesses of Marriott are lodging, contract services and restaurants, the investments should be closely related to that business and covered in homogenous industries when using the same WACC for evaluation. For instance, if Marriott were considering to invest a shopping plaza located on the central of the city, the cash flows associated with this decision have very different market risk from the cash flow associated with their typical project of incorporating a number of small hotels and therefore of expanding their lodging capacity, and it should use a different cost of capital.
If Marriott’s used a single corporate hurdle rate for evaluating investments opportunities in each of its lines of business, what would happen to the company over time?
It is not logical to use the overall corporate hurdle rate to discount divisional or project-specific cash flows that don’t have the same risk as the company’s average cash flows. Different capital structure and different sensitivities for market risk...