- This topic has 3 replies, 2 voices, and was last updated 12 years ago by
.
- Posts
Hi John,
Can we use CAPM as the discount rate for appraising a project with a different risk profile when the company has decided to finance the project without changing the gearing or must we use the risk adjusted WACC?
Also when do we use Adjusted Present Value method for appraising a Project?
Thank you.
The risk adjusted WACC is using CAPM.
You should find the beta for the project (using usually that of a similar company, but it depends what you are given in the question). Then you should calculate an equity beta using the existing gearing of the company doing the project, and then you should calculate a WACC to apply to the project using the cost of equity calculated from the equity beta already calculated.
APV in not the syllabus for F9 (only for P4) but it is used when there is a significant change to the gearing of the company.
I am sorry for posting a vague question.
What I meant was, when could we use the CAPM (calculated using the adjusted equity beta) for appraising a project which is being financed without changing the gearing of the company?or is it that we always must use risk adjusted WACC for similar situations?
And what if the gearing is being changed? is this not included in F9?I am asking this because I came across a question in BPP revision kit that used APV when gearing was changed.
thank you for the detailed explanation earlier.
You should treat the project as though it is a little company (separate from the company itself).
So….you should find the beta for the project (either it will be given, or you should use the beta for a similar company and remove the gearing of the similar company to get the asset beta).
If the project is being financed all from equity, then the discount rate is the return calculated for the beta of the project.
If debt is being used to part finance the project, then you should calculate the equity beta (using the gearing of the project), then calculate the cost of equity using that beta, and then a weighted average cost of capital for the project.
If it is asked in the exam, then almost certainly the project will be financed in the same gearing ratio as the company is already financed. Then you use the companies gearing ratio to work out an equity beta and then carry on as above to get the weighted average cost of capital for the project.
If the BPP question really does use the Adjusted Present Value approach (which is calculating the NPV as though it was all equity financed and then adding on the tax benefit of any debt raised) then they should not have done – it is not in the syllabus for F9. Only for P4!
- You must be logged in to reply to this topic.