Construction of a project is expected to begin at t=5 and the NPV of the project is determined to be $X at t=5. It seem logical that the future (t=5) NPV should be discounted to t=0 to determine the current value of the project for comparing with other projects. However, funding of the project won’t take place until t=5, so it doesn’t seem right to use the firms WACC (no money will be committed until t=5). What is the correct discount rate to use to discount the t=5 NPV to t=0? Should an opportunity cost of excess cash be used? Or should a risk free rate be used.

Question

jamesj · Answer

Suppose that it was necessary to invest one dollar, $1, at t=0 in order to realize this project.  In this case, there would be no question of the appropriate discount rate: it would remain the WACC.

The investments in year 5 will still be competing with other projects for the capital, whether or not we are making the decision now or not.

So even if we invest no money today, t = 0, the discount rate remains the same as any other project that requires investment today.

anonymous · Answer

Thanks for the answer James. After thiking about it a bit longer I came to the same conclusion.