Multiperiod Financial Discount Rates in Project Appraisal
The typical assumption about cash flows in perpetuity is not appropriate in practical project appraisal because the length of project life is always finite. In this paper, I present and discuss the calculation of multiperiod financial discount rates for a project with a finite life and no personal taxes. The impact of corporate taxes and inflation will also be included in the analysis. With financing, there are two possible profiles. First, we may assume that a constant debt-equity ratio is maintained during the life of the project. The loan schedule is constructed to keep the debt-equity ratio constant for the life of the project. Second, the loan schedule may be fixed. In this case, the debt-equity ratio changes over the life of the project. By explicitly calculating the appropriate discount rate for each period, we can explicitly model the cashflow statement from the Total Investment Point of View (CFS-TIP) and the Equity Point of View (CFS-EPV). It is not necessary to assume that the debt-equity ratio is constant and the cash flows are in perpetuity.
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