In reading 25, Capital budgeting, EOC question 44: This is regarding statement 4 from item set. It says that discount rate changes to 13%. In the solution, they have applied the new discount rate only to the difference in cash flow in year 3. Shouldn’t the new discount rate be applied to the whole series of cash flows?
When does the capital structure change?
The capital structure does not change. The question is :
Assuming a 13 percent discount rate, what will be the increase in the sailboat project’s NPV if the expected market value of the facility at the end of project is 15 million rather than 5 million?
what the answer did was to only solve for the effects of a change in the ending salvage value. The CFs before were not considered, as the answer took a shortcut. You would get the same answer if you calculated the difference in NPVs using the 5 million and 15 million salvage values.
Yeah, I got that part. I want to know why though? Why do we apply only to the last cash flow and not the previous cash flows?
If you calculated both NPVs and found the differnce, you applied 13% to all CFs. However, you dont need to find both of the NPVs to solve for the effect of a change in ending salvage value. The answer provided was a short cut.