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strategy processes
Published in Peter W. Robertson, Supply Chain Analytics, 2020
Taking the no terminal value scenario, the first indicator is net present value (NPV). NPV is determined by calculating the present values of future cash flows (sometimes called the discounted cash flow, DCF) and netting them against the project’s cost (NPV = PV – cost). Present values (PVs) represent the present value of future cash flows. The future cash flows thus are discounted by a discount rate, which is usually an organisation’s weighted average cost of capital (WACC). This discounting process is to allow for the fact that whilst the project cost is committed up-front, the benefits (i.e. cash flows) do not occur until sometime in the future. If the project funds instead were invested in, say, fixed-term deposits with interest paid quarterly, then cash flows would start next quarter and continue every quarter, not, say, five years in the future. Using WACC as the discount rate provides an extra safeguard as well because an organisation’s WACC is usually higher than available interest rates on safe investments. If, therefore, a project’s WACC discounted future cash flows are greater than the project cost, then organisational leaders can be reasonably confident that the project will add value.
Economic analysis of projects
Published in J.C. Edison, Infrastructure Development and Construction Management, 2020
Afinancial evaluation will disclose the capability of the project to create sufficient incremental cash flows to cover its (i) financial costs, (ii) capital and (iii) recurrent costs. In this respect, an investigation of the cost recovery goals and mechanisms of the project is significant because a financial evaluation is worthless without full cost recovery. The weighted average cost of capital (WACC) is used as the benchmark to assess the financial viability of aproject. The WACC is determined by ascertaining the actual lending (or on-lending) rates, together with the cost of equity contributed as a result of the project. To obtain the WACC in real terms, the inflation factor is deducted from the estimated cost of borrowing and equity capital (ADB, 1999b). In the case of entire cost recovery, the financial NPV discounted at the project’s WACC must be more than zero, and the financial internal rate of return (FIRR) must be more than the WACC. Afinancial evaluation helps in deciding whether or not to proceed with a project. Projects with low returns are riskier to implement and strain the financial sustainability of the corporate entity (public or private) charged with its operation and maintenance. Consequently, it is important to keep these issues in mind when comparing the FIRR of a project against a benchmark such as the WACC. These issues become particularly important as the role of government in the supply and O&M of infrastructure services changes and private sector participation becomes more prevalent (ADB, 1999b).
Regulating light water reactors in the United States
Published in Geoffrey Rothwell, Economics of Nuclear Power, 2016
A real WACC of 10% is the baseline real cost of capital for a ‘merchant’, unregulated nuclear investor in the United States and equal to the cost of capital assumed for all electric utilities in the US EIA’s NEMS. The US EIA describes how WACC is determined for all electric utility investments by the electricity capacity planning (ECP) subroutine: The model performs a discounted cash flow analysis of the costs of building and operating power plants over 30 years and chooses the least cost mix of options. The ECP assumes that building power plants will take place in a competitive environment rather than in a rate base or regulated environment. Each year, the assumptions and parameters for discount rates and the weighted average cost of capital (WACC) are reviewed to reflect the changing nature of the power industry and to incorporate new capital market information. For example, since the AEO2004, the US EIA has increased the equity portion of project financing and the return required on equity to reflect the greater risk associated with investments in a deregulated market. The discount rate (WACC) is a very important component because the rate reflects the riskiness of the investment and affects the mix of capacity additions … small changes in the weighted average cost of capital lead to huge changes in capital intensive capacity additions.(US EIA, 2013: appendix 3.C, ‘Cost of capital’, emphasis added)
Bioethanol processing from wheat straw: investment appraisal of a full-scale UK biofuel refinery
Published in Biofuels, 2023
Geoffrey P. Hammond, Niall McCann
This approach takes account of the ‘time value of money’ and discounting in order to obtain the appropriate investment appraisal criteria [55–58]. The net present value (NPV) of the sum of the capital cost, maintenance and operational costs, as well as (potentially) plant decommissioning, is calculated over the life of the project, along with the NPV of the total fuel produced. Consequently, by using this method, different technical options with a variety of lifespans, capital costs, and efficiencies can effectively be compared so that the most cost-effective option can be determined. In the case of public sector investments a so-called Test Discount Rate (TDR) is utilised in the UK. It is typically derived from a comparison with private sector discount rates {forming the Weighted Average Cost of Capital (WACC)}. In the UK, HM Treasury [59] recommends that the TDR for projects with durations of less than 30 years should be taken as 3.5% in real terms. An exception is applied for projects involving risk to life, when a lower rate of 1.5% is employed [59].
Risk-adjusted discount rates and the present value of risky nonconventional projects
Published in The Engineering Economist, 2020
Anastasia N. Blaset Kastro, Nikolay Yu Kulakov
As we noted above, the risk-free rate is a rate of return that is free of default risk, usually the yield to maturity on a U.S. government security. In the case of investment in a risky project, the COC (or RADR) is determined as the sum of a risk-free rate and a risk premium. There are several ways to evaluate an investment project, to name but two: the free cash flow method and the equity residual method (or free cash flow to equity, FCFE). In the former case the weighted average cost of capital (WACC) is used as the discount rate in the NPV determination. In the latter case the discount rate is the cost of equity a shareholder expects to have taking into account the risk, i.e. CAPM. Using the second approach we determine the RADR as a post-tax rate, with FCFE calculated taking into account interest and tax payments.
Methodological approaches to supply chain design1
Published in International Journal of Production Research, 2018
Gema Calleja, Albert Corominas, Carme Martínez-Costa, Rocío de la Torre
Additionally, since the design of a SC envisages a time horizon of several years, the time value of money should be considered. Based on the financing of the SC, the cost of capital should be used to discount the cash flows and to calculate the present value. The discounted free cash flow method uses the weighted average cost of capital (WACC) for discounting, as a combination of returns needed to compensate creditors and shareholders. In contrast, within the flow-to-equity approach, the equity discounting factor should be used (e.g. Steinrücke and Albrecht 2016, determine the discounting rate according to the capital asset pricing model – CAPM – for the cost of equity capital of a levered company).