Capital Budgeting, Investment Project Valuation and Financing Mix : Methodological Proposals

The results presented here are part of research work originally based on the problem concerning the valuation of investment projects subject to specific fiscal rules, such as those encountered in the upstream oil industry. More precisely, the first question addressed was how to determine the economic value of an investment project partly financed by borrowing, when the revenue from the project is subject to a different tax rate from the one used to calculate the discount rate, and when the loan allocated to the project is different from the one corresponding to the target debt ratio defined by the company for this type of projects. We propose a method which is, in fact, more general in scope. It is presented in the first part of this article and corresponds to the adaptation of classic ATWACC calculations. A simple answer is to add each year, to the project cash flow, an after tax loan cost differential (negative or positive). The formulation adopted ("generalized ATWACC method") is independent of any consideration related to debt ratios. The second question addressed here is the use of the Arditti-Levy (BTWACC) method, the one most commonly used in the Exploration-Production branch of the oil industry. While the method is appropriate to deal with for complex specific tax rates, it needs to be adjusted if the company allocates to a project a loan representing proportionally more (or less) than the fraction corresponding to its consolidated debt ratio. A suitable approach is developed here. However the formulation, by further complicating a method which in any case cannot be used without precaution, does not possess the simplicity of that of the generalized ATWACC method, and the latter should therefore be preferred in all situations.