Investment Project Valuation: A New Equity Perspective

Abstract

We suggest a new approach to calculating a project's net present value, termed the displaced equity method. Based on a straightforward formula, it analyzes a project partially financed with debt from the perspective that every year the amount of outstanding debt displaces an equivalent amount of equity that otherwise would be tied up in the project. Although they represent distinct shareholders' perspectives, the displaced equity method and the equity residual method yield identical net present values and internal rates of return. Every year, the project's value calculated with the displaced equity method is equal to the sum of the project's debt and equity values. In practice, when the schedule of expected outstanding debt amounts is known, using the displaced equity method is an easy way to estimate the project's net present value.