Assignment 5 – Corporate Finance in Emerging Markets
1. “The Adjusted NPV approach is fundamentally wrong because Free Cash Flows are not
discounted with the weighted average cost of capital”. Do you agree or disagree? Explain
your answer.
ANPV and WACC are the two most commonly discussed valuation approaches in literature.
Whereas the WACC-approach discounts all future cash flows of a project at one single discount
rate, namely the after-tax weighted average cost of capital of the project, the ANPV seperates
the cash flows into categories and uses a specific risk-adjusted discount rate for the respective
bucket to discount the cash flows.
The fundamental idea of the ANPV is to unbundle components of real value, namely the base
case value of a fully equity financed project if the project is undertaken, and then takes other
side effects into account. Possible side effects are for example the value of all financing side
effects (interest rate effect, cost of financial distress, subsidies, hedges, issue costs, tax savings,
etc.) and value of potential growth opportunities.
If applied correctly both methods should finally derive at the same value and thus result in the
same investment decision. This becomes obvious considering that the WACC approach simply
discounts the total portfolio of potential revenues streams with the corresponding discount
rate weighted or adjusted by each risk effect incorporated by the portfolio whereas the ANPV
unbundles the portfolio of potential revenue streams and then applies an individual risk-
adjusted discount rate. Against this background, the ANPV approach cannot be considered
fundamentally wrong as both approaches follow the same underlying logic and apply the
appropriate risk-adjusted discount rate to the respective returns. The WACC-approach just
does it on a portfolio basis whereas the ANPV-approach breaks the investment down into its
single parts.
