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hello Sir,
plz explain the following linesIf the existing capital structure will be maintained in the long run, although it has been altered for a specific project, the current WACC may be used to appraise the new investment project.
Where the existing capital structure is altered to fund a new investment project, the marginal cost of capital
may be a more suitable discount rate to use.thanks in advance
A project should be appraised at whatever the cost of money is for the project.
If the gearing of a company stays unchanged, then the WACC will stay constant (assuming no change in business risk) and therefore the cost of money remains the same and we can discount at the WACC.
If the gearing changes then the WACC is going to change and so the previous sentence is not longer true. We would then need to calculate what the cost of the money raised for the project was – this is called the marginal cost of capital.
In Paper F9 you can not be asked to calculate the marginal cost of capital – all of the above is only relevant for a written part of a question.
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