18-10-2010, 04:13 PM
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Discussion: Discount factor issues
WACC is appropriate discount factor when:
The new project has the same risk profile as the firm as a whole
The new project uses the same financial structure as the firm as a whole
No special financing connected to the project
Financing for the project is taxed the same way as all other financing for the firm
Discussion: Cash flow issues
Most cash flow issues do not affect validity of WACC as a discount factor. (Unless they raise one of the above issues.)
However, if WACC must be abandoned, it does have implications for cash flows considered. Specifically cash flows related to financing (which are normally ignored) must be considered.
Cash flows ignored using WACC
Financing for the project
Example: Financing for the previous WE example involved receiving $5M in proceeds of a bond issue; annual interest payments (at 14%) of $700,000 and an ultimate repayment of the $5M.
Why are these cash flows ignored?
