Answer to Question #82402 in Finance for Adnan rafi

Question

Q6)Company versus Project Discount Rates.Geothermal WACC is 11.4 percent. ExecutiveFruit’s WACC is 12.3 percent. Now Executive Fruit is considering an investment in geothermalpower production. Should it discount project cash flows at 12.3 percent? Why or whynot?

Answer 1

In order to discount project cash flows Executive Fruit should use company’s WACC, 12.3 percent, because WACC represents the cost of capital for this particular company, with its proportion of equity and debt. In case of using Project Discount Rate we don’t know which category of capital is used and how much does it cost for Executive Fruite. But we have to compare risks of the geothermalpower production with average risks of the firm, if the business risk of new project is quite higher than the global company risks, we cannot use the company's WACC in pure form and we must take into account the risk component.