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

The results presented here are part of research work originally based on the problemconcerning the valuation of investment projects subject to specific fiscal rules, such asthose encountered in the upstream oil industry. More precisely, the first question addressedwas how to determine the economic value of an investment project partly financed byborrowing, when the revenue from the project is subject to a different tax rate from the oneused to calculate the discount rate, and when the loan allocated to the project is differentfrom the one corresponding to the target debt ratio defined by the company for this type ofprojects. We propose a method which is, in fact, more general in scope. It is presented inthe first part of this article and corresponds to the adaptation of classic ATWACCcalculations. A simple answer is to add each year, to the project cash flow, an after taxloan cost differential (negative or positive). The formulation adopted (“generalizedATWACC method”) is independent of any consideration related to debt ratios. Thesecond question addressed here is the use of the Arditti-Levy (BTWACC) method, the onemost commonly used in the Exploration-Production branch of the oil industry. While themethod is appropriate to deal with for complex specific tax rates, it needs to be adjusted ifthe company allocates to a project a loan representing proportionally more (or less) thanthe fraction corresponding to its consolidated debt ratio. A suitable approach is developedhere. However the formulation, by further complicating a method which in any casecannot be used without precaution, does not possess the simplicity of that of thegeneralized ATWACC method, and the latter should therefore be preferred in allsituations.