Question

Write a 200 word response to the following discussion answer

Projects are financed by equity, debt and other sources to determine the discount rate we must estimate the costs of all sources. The projects should only be accepted if they generate a return (www.nscpolteksby.ac.id). Superior's cost of capital is .12 + .75(.08) = 18%. Using this discount rate, the proposed project has a positive NPV. Superior should invest in the project, because it has a positive NPV.

Answer 1

As is mentioned in the discussion prompt, projects are financed by means of various capital sources such as debt, short-term debt, revolving credit, bridge loans, qualified institutional placements, follow-on public issue, initial public issue, preferential share issue, convertible debt issue and more. All of these and more primarily fall in either of the two categories of debt and equity. The discount rate of any project is a value-weighted average of the cost of each of this aforementioned sources of capital(the capital sources used for actual financing are to be considered for cost calculation).

Further, only those projects should be accepted which generate or accrue value to the entity undertaking the project. A sure way of determining if the project generates value for the undertaking entity is to calculate the project's NPV (net present value) using the discount rate discussed in the last paragraph. If the NPV is positive it implies that the project is value accruing to the entity and if the NPV is negative then it is value eroding to the entity. Needless to say the former is preferred and hence all projects with positive NPVs are to be accepted. In conclusion, if the discount rate of 0.18 leads to a positive NPV (as mentioned) Superior should invest in the project as the same would be value accruing to Superior.