BUSF_A01.qxd

Chapter 10 • Cost of capital estimations and the discount rate

therefore, be inappropriate for a project that is either more or less risky than the

average for the business as a whole. There are two approaches to trying to deal with

this problem.

1 Estimate, on the basis of the particular project’s perceived riskiness, by how

much the business-wide WACC needs to be adjusted to be appropriate as the

required rate of return (discount rate) for the particular project.

2 Find a business that specialises exclusively in projects of the same nature (and,

therefore, riskiness) as the particular project and use that business’s WACC as

the discount rate.

10.5 WACC values used in practice

To put things into perspective, Dimson, Marsh and Staunton (2002) estimate that real

(that is, inflation-free) returns on equity, for UK businesses, over the whole of the

twentieth century, averaged about 6.5 per cent p.a. This is, in effect, the average cost

of equity. Since most businesses have a significant element of borrowing, and debt

tends to lower WACC, we might expect that the rates actually used by UK businesses

would not be as high as 6.5 per cent.

Recent survey evidence (Gregory, Rutterford and Zaman 1999; Al-Ali and

Arkwright 2000; McLaney, Pointon, Thomas and Tucker 2004) indicates the mean real

WACCs found in practice in the UK to be in the range 7 to 9 per cent, though many

individual businesses estimate their WACCs at values outside this range.

Table 10.1 sets out the WACCs of some well-known UK businesses.

Table 10.1WACCs of some randomly selected businesses

Business WACC

per cent

Associated British Foods plc (food manufacturer) 9.5

BP plc (oil) 10.0

BT Group plc (telecoms) 10.7

Carphone Warehouse Group plc (telecoms) 6.8

J D Wetherspoon plc (public houses) 5.6

Kingfisher plc (DIY stores) 6.9

Prudential plc (insurance) 9.6

Tesco plc (supermarkets) 13.5

Source: The annual reports for 2006 or 2007 of the businesses concerned

Note that in some cases businesses show a range of values that they use as their discount rates. The table shows

the mean (average) value for the range where this is the case.

The values found by McLaney et al.and those shown in Table 10.1 seem on the high

side given the findings of Dimson et al. It must be said that none of the businesses

listed in Table 10.1 indicates whether they are stating the ‘real’ or ‘money’ figure. If

any of them are giving the money figure, this needs to be reduced by 2 to 3 per cent to

obtain an approximation on the real one. Presuming that WACC is used by the busi-

nesses surveyed as their discount rates for assessing investments (and that the real