Investment Project Analysis and Financing Mix: A New Method in Sight?

Abstract

Profitability studies for investment projects may use different methods to account for the manner in which the project is financed. These methods include the After Tax Weighted Average Cost of Capital (ATWACC, overall return), the equity residual method, the ARDITTI method (Before Tax Weighted Average Cost of Capital) and the Adjusted Present Value method. The discount rates and determination of cash flow differ for each method. For example, the ATWACC calculations, which are the most commonly used, are based on operating cash flows that exclude debt cash flows. Return on equity calculations are based on equity cash flows that include cash flows associated with the external financing, whereas the ARDITTI method (shadow interest) involves tax credits related to the deductibility of interest payments without reporting the credits from loans nor the corresponding principal repayments.

The method described in this paper involves cash flows that, in addition to operating cash flows, include the cash flows related to the payment of interest on loans and their incidence on tax. However it does not take into consideration loan cash inflows nor loan capital repayments.

The purpose of this paper is to compare this method with previous ones in order to determine the conditions required for its validation. An attempt is made to identify the possible fields of application.