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Hi ACCA’s or fellow accountants,
I am to answer a question regarding under what circumstances Costs of capital was used as discount rates?It is only appropriate when:
1. The project and the company have the same business risk
2. The project is small relative to the company
3. The existing capital structure will be maintained, i.e the project will be financed using the same proportion of debt and equity that is in the company’s current capital structure.and to expand;
1. if it doesn’t have the same business risk then you should use a project specific discount rate using CAPM. Ungearing/regearing etc…
2. I don’t think this is quite right. You can use WACC as a discount rate on large projects assuming the business and financial risk are the same. WACC is still appropriate on smaller projects if the risks are different. I may be incorrect but I’m pretty sure that this was an “or” and not an “and” in the Kaplan text book
3. If the existing capital structure is not maintained then you should consider adjusting the AC by the MCI hope that this helps
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