Page 134 - AFM Integrated Workbook STUDENT S18-J19

Chapter 7

1.4 Overview of when to use each method

 The basic idea is that any discount rate should reflect project business
risk and project financial risk (capital structure).

 Two key questions must therefore be asked:

– Does the project have a different level of business risk from
the company?

– Will the finance package chosen change the overall capital
structure (gearing level) and hence the financial risk of the
company? For example, using just equity or just debt is likely
to change the overall gearing level.

 There are four possible outcomes.
Project business risk

Same as company Different

Use existing Calculate a project-

Constant company WACC as specific risk-adjusted
Impact gearing a discount rate WACC
of
project
finance

Change in Adjusted present Adjusted present

gearing value value

 Each of these approaches is explained in more detail below.

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