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Adjusted present value

LLyndon9d ago

Hi, I’m confused about the annuity factor used when calculating the financing effects in APV.

I understand that for the base-case NPV, we use the appropriate project discount rate. However, when calculating the financing effects (e.g. tax shields, subsidy benefits, etc.), I’m not sure which rate should be used in the annuity factor formula.

For example, if I need to calculate an annuity factor for a financing benefit over several years, should I use:

  • the risk-free rate,

  • the pre-tax cost of debt,

  • the interest rate used for subsidised loans, or

  • some other rate?

I’ve seen examples where different rates are used, and I’m getting confused about how to decide which rate to use for the AF in APV financing effects.

Please advise on this.

John MoffatJohn MoffatTutor8d ago#1

The examiner accepts either of the risk free rate or the pre-tax cost of debt (as I do explain in my free lectures). In theory the two would be the same but obviously usually they are not the same. Just make sure that you state which rate you are using and you will get the marks for using either of them.

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