Interactions of corporate financing and investment decisions: the financing present value (“FPV”) approach to evaluating investment projects that change capital structure

Abstract

Proposed projects whose financing will cause capital structure to change across time cannot be accurately evaluated by the ordinary Weighted Average Cost of Capital‐Net Present Value technique. The required rate of return on a new project depends on the firm’s capital structure through the effect of capital structure on the required rates of debt and equity suppliers. But the capital structure depends on these required rates, which are themselves functions of capital structure. There is no general analytical solution to this circularity, so the ordinary weighted average cost of capital cannot capture the effects of changing capital structure on the cost of capital, and the computed NPV is not correct: the wealth of the shareholders will change by a different amount, and may have a different sign as well.

Citation

Wood, J.S. and Leitch, G. (2004), "Interactions of corporate financing and investment decisions: the financing present value (“FPV”) approach to evaluating investment projects that change capital structure", Managerial Finance, Vol. 30 No. 2, pp. 16-37. https://doi.org/10.1108/03074350410768886