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)

Fulbright Economics Teaching Program Working Paper

40 Pages Posted: 10 Mar 2000

See all articles by Joseph Tham

Joseph Tham

Educational Independent Consultant

Tran Viet Thang

SAIGON COMMERCIAL BANK (SCB); affiliation not provided to SSRN

Date Written: August 1999

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.

JEL Classification: D61, G31, H43

Suggested Citation

Tham, Joseph and Thang, Tran Viet and Thang, Tran Viet, 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) (August 1999). Fulbright Economics Teaching Program Working Paper, Available at SSRN: https://ssrn.com/abstract=211533 or http://dx.doi.org/10.2139/ssrn.211533

Joseph Tham (Contact Author)

Educational Independent Consultant ( email )

Tran Viet Thang

SAIGON COMMERCIAL BANK (SCB) ( email )

4- HO XUAN HUONG
Hanoi, 10000
Vietnam
084-04-9438732 (Phone)
084-04-9438734 (Fax)

affiliation not provided to SSRN

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