Multiperiod Financial Discount Rates in Project Appraisal: The No-Tax Case (Suat Chiet Khau Tai Chinh Nhieu Giai Doan trong Tham Dinh Du An: Truong hop Khong Co Thue)

Abstract

The typical assumption about cashflows in perpetuity is not appropriate in practical project appraisal because the length of project life is always finite. In this paper, I discuss the calculation of multiperiod financial discount rates for a project with a finite life. For simplicity, I assume that there are no taxes. The analysis is conducted without and with inflation. There are two possibilities for calculating the discount rates. First, we may assume that a constant debt-equity ratio is maintained during the life of the project. In this case, the loan schedule is constructed to keep the debt-equity ratio constant for the life of the project. Since the debt-equity ratio is constant, the Weighted Average Cost of Capital (WACC) and the return to equity e will be constant. Second, the loan schedule may be fixed for the life of the project. In this case, as the loan is repaid, the debt-equity ratio changes because the principal is being repaid over the life of the project. In each period, the return to equity e will be a function of the debt-equity ratio for the period. The return to equity e varies with the change in the debt-equity ratios. The return to equity e will be adjusted to keep the WACC constant. By explicitly calculating the appropriate discount rate for each period of the project with a finite life, it is not necessary to assume that the debt-equity ratio is constant and the cashflows are in perpetuity.