WACC and Free Cash Flows: A Simple Adjustment for Capitalized Interest Costs

Posted: 31 Mar 2010

See all articles by Axel Pierru

Axel Pierru

King Abdullah Petroleum Studies and Research Center (KAPSARC)

Date Written: March, 26 2010

Abstract

This paper shows how to value investment projects involving capitalization of interest costs by using the standard WACC method. Whenever capitalized interest costs do not immediately generate proportionate tax shields, one of the assumptions that justify the use of the after-tax weighted average cost-of-capital formula is violated. As an offset to this violation, the project's free cash flows have to be adjusted. We here derive and interpret a simple adjustment formula. A numerical illustration is provided.

Keywords: capitalized interest, WACC, APV, interest tax shield, capitalization

JEL Classification: G11, G3

Suggested Citation

Pierru, Axel, WACC and Free Cash Flows: A Simple Adjustment for Capitalized Interest Costs (March, 26 2010). Quarterly Review of Economics and Finance, Vol. 50, No. 2, 2010, Available at SSRN: https://ssrn.com/abstract=1578807

Axel Pierru (Contact Author)

King Abdullah Petroleum Studies and Research Center (KAPSARC) ( email )

Riyadh, Central Province
Saudi Arabia

HOME PAGE: http://www.kapsarc.org/

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