I have a practical capital budgeting question for a personal project and thought that one of you smart cookies could guide me into how I should be thinking about it. Basically I am trying to do an NPV calculation for a project in which I would be buying a machine and then estimating the returns over a 5 year period.
My question is regarding how I should be thinking about discount rates and financing. Obviously the application of capital budgeting that we use for the CFA is generally listed companies and we are provided discount rates and/or calculate them ourselves. But I am not sure how I should be thinking about my own cost of capital.
I am thinking that it will be a combination of my opportunity cost (ie my ability to take my savings and invest them in the equity markets at lets say a return of 10% a year) and something else. Would I also include a financing cost in my discount rate? Seeing as we don’t include interest costs in NPV calculations as the NPV uses unlevered cash flows, do I somehow include the borrowing rate in my discount rate if I was debt financing? Like 8% borrowing rate + 10% opportunity cost of capital = discount rate of 18%? I am not confident this is the way to do it and am just laying down my thoughts. Any ideas/direction to where I could learn about this would be much appreciated.
Is this project going to earn money? if not using an NPV might be tricky, although I suppose you could try to but some sort of dollar equivalent number on your personal happiness. If it will, this project is financed using debt, debt that I’m guessing your going to use the proceeds you earn to pay back? This seems more like an LBO model than a DCF to me. https://www.macabacus.com/lbo-model/introduction As for the discount rate, I would just use 20%, if this is a personal project and your putting your time into it expect a pretty high return. Thats my opinion at least.
WACC = ((debt x rate) + (equity x rate)) / (debt+equity) Any debt you use should be at that rate, and the equity rate should be your opportunity cost (what you could get investing that cash elsewhere, or paying off other debt). Question would be whether to use just a project specific WACC or your overall WACC… Could be open for debate.
Remember that WACC needs to be adjusted for riskiness. If your project requires beating Michael Phelps in the 400 butterfly, the cost of equity on your project should be around 90% at least, even if the equities market gives you around 8-10%
^ Yes. I should have said equally risky alternatives in my answer. That said, most machinery purchases at home, to defer opex later, ate extremely low risk. Buying a higher efficiency furnace to decrease gas costs over the next ten years has a very low equity opportunity cost. Buying some weights or a treadmill to end gym fees is low risk. Trying to compete with Phelps is obviously higher.