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Hi
Sorry if this is an obvious question. Just wanted to clarify what discount rate should be used for project appraisal where there is specific borrowing available.
For example a company wishes to invest in a project financed by a bank loan.
Bank loan interest: 10%
WACC: 12%My initial thoughts were if retained earnings were being used to finance the project (company’s own pool of funds) then the WACC should be used and if there was specific borrowing as above for the project then the loan interest should be used.
But it wouldn’t make sense to invest in the project in the first place if it wasn’t generating a positive NPV @12% to fulfil the company’s financial obligations even if the specific borrowing was lower @10%. I feel its more prudent to always use the higher rate of the two (if information is given and option available).
Please can you shed some light on this and if there are any general rules of thumb I should be aware of.
Thanks!
Khurram
Now that I think about it taking out the new loan may change the WACC anyway so should a new WACC calculation be performed including the new loan @10%. This might change the WACC from 12% to 11% so would the most appropriate discount rate be 11% now?
I think I’m confusing myself!
Hi,
We will use the WACC as this will reflect the risk of taking on the new loan. If we use the rate on the loan itself then this will not fully reflect the risk.
Thanks
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