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ACCA Strategic Professional · Advanced Financial Management · Impact of financing on investment decisions and adjusted present values

A multinational is appraising a project whose financing is unusual. It will use a subsidised government loan and a one-off share issue, and the project's debt level will differ from the company's existing gearing. Which feature of the adjusted present value (APV) method makes it more suitable here than NPV at the company's existing WACC?

APV is more suitable because it values the project as if all-equity financed and then adds the financing side effects, such as subsidised loan benefits, tax shields and issue costs, separately. WACC-based NPV assumes constant existing gearing and cannot capture project-specific financing.

  1. AIt values the project first as if all-equity financed and then adds the separately valued financing side effectsCorrect
  2. BIt uses a single blended discount rate that automatically reflects the new gearing
  3. CIt ignores the tax relief on interest to avoid double counting
  4. DIt discounts all cash flows at the cost of debt because the project is debt financed

Explanation

APV starts with a base-case NPV discounted at the ungeared cost of equity and then adds the PV of financing side effects such as tax shields, subsidies and issue costs. This lets project-specific financing be valued explicitly. A WACC-based NPV assumes the existing capital structure and business risk, so it cannot handle these effects well.

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