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Hi, for the sample answer, please may I know the rationale of using the ungeared cost of capital (9%) instead of the given geared cost of capital (10.5%) in order to calculate the NPV?
Thank you.
It is because we are calculating the APV, and for the APV we always calculate the base case NPV as if the project were entirely equity financed (in which case the cost of equity is the ungeared cost of equity) and the separately deal with the tax shield on the debt (and any subsidy benefit).
I explain the logic of this in my lectures on APV.
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