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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 project's base-case operating cash flows normally discounted?

Base-case cash flows in APV are discounted at the ungeared cost of equity, which reflects the project's business risk as if all-equity financed. Financing side effects are added separately, so using the WACC would double count the effects of gearing.

  1. AThe ungeared (all-equity) cost of equity reflecting the project's business riskCorrect
  2. BThe company's existing weighted average cost of capital
  3. CThe after-tax cost of debt
  4. DThe risk-free rate

Explanation

APV first values the project as if it were financed wholly by equity, so the operating cash flows are discounted at the ungeared cost of equity for the project's business risk. Financing side effects such as tax shields and issue costs are valued separately. Using the existing WACC would mix financing effects into the base case and double count them.

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