Question

Dr. Pepper, a manufacturer of beverages, is planning to purchase Canada’s Wonderland theme park. Should Dr. Pepper use its own WACC as the discount rate to evaluate the business of Canada’s Wonderland or should it use Canada’s Wonderland’s WACC? Explain your answer

Answer 1

Dr. Pepper should use the WACC of Canada's Wonderland as the discount rate to evaluate the business. The discount rate is a measure of the risk in the business and as such it makes sense to use the WACC of the business being evaluated. The Wonderland's WACC should reflect the risk in its cash flows, growth, and the timing of the cash flows.

Using Dr. Pepper's WACC is incorrect. Suppose Dr. Pepper's WACC is lower than Wonderland's WACC, then Dr. Pepper may accept the risky business, which otherwise would have rejected if Wonder'and's WACC is used.