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my understanding so far: when calculating the NPV of an investment project, we use the given after-tax WACC (unless this WACC has to be recalculated because gearing will change, or the business risk of said project is different from the existing one for the company).
i ask because in two question on investment appraisal the information given was:
Q33(to buy or not to buy):
-The finance director has proposed that the $3.4 million investment should be financed by an issue of loan notes at a fixed rate of 8% p.a
and
The company uses an after tax DF of 12% to evaluate investment proposals.
Tax is 30%
=the solution provided used the 12% to discount the cash flowsbut in
Q36 (lease or buy):
– if the company bought the new technology it would finance the purchase through a loan paying interest at an annual before tax rate of 8.6%.
and
the company has an after tax WACC of 11% pa.
Tax is 30%
=the solution provided used the 6% (=0.7 X 8.6%) to discount the cash flows for both the lease and buy NPV calculations.im sorry to ask but what am i missing?
i would have used after tax WACC in both questions. why is this not correct for the second question?Thank you
When appraising investments we use the after-tax WACC.
In lease and buy questions, we are not appraising an investment, we are not appraising an investment – we are deciding which is a cheaper way of getting the asset, leasing or borrowing and buying. Therefore we discount the flows at the cost of borrowing.
You should watch my free lectures on lease and buy. The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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