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

In the adjusted present value (APV) method, at which rate are the base-case after-tax operating cash flows of a project normally discounted?

Base-case operating cash flows in APV are discounted at the ungeared cost of equity for the project's business risk. This values the project as if all-equity financed, and financing side effects such as tax shields and issue costs are then valued separately and added.

  1. AThe company's existing weighted average cost of capital
  2. BThe ungeared cost of equity appropriate to the project's business riskCorrect
  3. CThe after-tax cost of the new debt raised for the project
  4. DThe risk-free rate of return

Explanation

APV first values the project as if it were all-equity financed, so base-case cash flows are discounted at the ungeared cost of equity reflecting the project's business risk. The existing WACC embeds the company's current gearing and tax shield, which APV deliberately treats separately.

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