Comments

  1. avatar says

    Dear John,
    Its quite easy and logical. what is project-specific and marginal cost of capital…and if waac is not suitable for unsimilar business risk situation, then is it same to simple interest rate( cost of cap.)?

    • Profile photo of John Moffat says

      I am not completely sure what you mean (‘is it same to simple interest rate….’).

      Usually we discount at the WACC, and this assumes that the gearing is remaining unchanged and that the business risk is remaining unchanged.

      You can be asked to deal with the situation we the business risk is changing. To do this we need to obtain an asset beta for the project (which is the measure of the riskiness); then we have to calculate an equity beta from the asset beta (using the existing gearing of the company); then we use that to calculate a cost of equity for the project (the project-specific cost of equity).
      Usually that is all that is required in the exam. However, if you were asked for it, in order to find an appraisal rate we then calculate a WACC for the project in the normal way, but using the project specific cost of equity (already calculated) in the calculation.

  2. avatar says

    Hi Stacy, , you get $1.39 because of in your workings you wrote 14.8-0.03 . it should be 0.148- 0.03 instead. try it , you will realize it, common mistake when we do it fast…

    cheerios

  3. avatar says

    Here return to shareholders, E(ri) is equal to cost of capital of the new project.

    I thought the question was asking for the minimum cash flow requirement in perpetuity for the project to be acceptable, in that case nearly 13,000 will give npv is zero, where project can be accepted.On that basis, 15,000 pa for ever is acceptable straight away as it gives a NPV of 15385 positive.

    A nice example to integrate investment appraisal and CAPM.

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