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I am reading some material. It mentioned for RISK ADJUSTED WACC
Two conditions apply:
a) Project is a non-core activity
b) The project finance will have no effect upon the company’s gearing ratio or a specified project finance gearing ratio applies.A-I get
My issue is B, since its risk adjusted -I am thinking changes.so I was expecting it to apply when the gearing changes. so risk adjsuted wacc should be used when bsuiness risk changes and financing changesthen i did some reading it said in AFM Exam Context
When the examiner says “risk-adjusted WACC”, they mean:
Adjusting for different BUSINESS risk
while assuming capital structure is constant. is this true?then i came across
BUSINESS RISK Different
FINANCE RISK Same
Risk-adjusted WACC
Adjust beta for new business riskBUSINESS RISK Same
FINANCE RISK Different (constant new target)
Recalculate WACC at new target gearing
Financial risk changes but is stablebUSINESS RISK Different
FINANCE RISK Different (constant new target)
Risk-adjusted WACC (using new gearing)
Adjust beta + regearBUSINESS RISK Same or Different FINANCE RISK Gearing changes over time APV WACC assumption breaks
CAN i USE IT?
The risk adjusted cost of capital for a project will normally be referring to that calculated using the assets beta of the project and is therefore accounting purely for the business risk (and not the gearing risk).
If both the business risk and the gearing risk change then we would use an adjusted present value approach (as explained in my free lectures).
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