Question

Should Exxon Mobil use the same WACC for all divisions( offshore exploration, gas stations). What about Kelloggs( cereal and cookies)?

Answer 1

The WACC or the weighted average cost of capital is a risk-adjusted return that should be used by the companies to discount the estimated free cash flows and to evaluate investments. In case of Exxon Mobil, the offshore exploration division is more risky as it entails large upfront capital expenditure and future cash flows are risky and contingent on finding a commercially useful reserve. Thus to capture this riskiness, the risk-adjusted return of this division should be more. On the other hand, gas stations is a retailing business and have lesser risk and thus should have a lower WACC to reflect this reality.

In the case of Kellogs, both cereals and cookies belong to the same segment or division and thus reflect the same kind of business risk. Hence they should have similar risk-adjusted return expectations and hence similar WACC.

Thus WACC should reflect the risk adjusted return expectation of the business of the division and could vary depending on the riskiness of that particular business division.