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

Nyala Ltd is an all-equity project-financed company with an equity beta of 1.20. Risk-free rate is 4% and market return is 9%. Under the APV approach, which rate should Nyala use to discount the base-case operating cash flows of a new project that has the same business risk as the existing business?

Use 10%, the ungeared cost of equity, because the firm is all-equity so its equity beta is its asset beta. The CAPM gives 4% plus 1.2 times the 5% premium. Base-case cash flows in APV are discounted at this rate.

  1. A10.0%, the ungeared cost of equity (4% + 1.2 × 5%)Correct
  2. B5.0%, the market risk premium
  3. C9.0%, the market return
  4. DThe after-tax cost of debt

Explanation

For an all-equity firm, the equity beta equals the asset beta. Ke = 4% + 1.2 × (9% − 4%) = 4% + 6% = 10%. The market return alone ignores beta, and the cost of debt is used for the tax shield, not base-case flows.

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