In the long-term investment decision, the net present value method is considered to be the best method.

The key to the evaluation of investment projects by net present value method is the determination of cash flow and discount rate.

Usually we use the net present value method to make decisions, only to evaluate the economic effects of the investment projects themselves.

At this point, the discount rate usually refers to the opportunity cost of invested capital, that is, the rate of return required by investors in the capital market with risk equivalent investment.

From the determination of the discount rate, we can see that the net cash flow per year can not deduct the interest of the debt, that is, the net cash flow of annual business should be: pre tax income (1 income tax rate) + depreciation; not our accounting: after tax profits + depreciation.

The calculation of net present value does not take into account debt financing, that is, the impact of financial risk on project evaluation.

In fact, net present value method can also take into account the effect of debt financing, that is, not only consider the economic effects of the project itself, but also consider the impact of the financing structure and financing costs on the project.

The following are four kinds of alternative net present value methods.

1., the cost of debt capital is considered in the discount rate, that is, the discount rate is the weighted average capital cost of project invested capital.

For example, a project invested capital of 1 million yuan, of which 50% is equity capital, capital cost is 14%; 50% is debt capital, interest rate is 10%.

The borrowing period is 4 years, and interest is paid at the end of each year.

The income tax rate is 40%, and the project is valid for 4 years.

The straight-line method is used to calculate depreciation, and the net cash flow forecast for each year is shown in Table 1.

The first year of the project is second years, third years and fourth years. The operating income is 90100120 180, the cash cost is 606575 105, the depreciation fee is 252525 25, the pre tax income 51020 50. The income tax 248 20. One unit: ten thousand yuan.

[2] + 37, (1 + 10%) [3] + 55 55 (1 + 10%) [4] 100 = 16.44 (10000 yuan) 2., the debt capital interest is used as a cash outflow and deducted from the net cash flow per year.

At the beginning, debt capital is manifested as cash inflow and cash outflow when debt is paid back.

This treatment is actually considered from the perspective of equity capital investors.

According to the above example, annual net operating cash flow can be obtained as shown in table two.

Two units: 10000 yuan, second years, third years, fourth years, business income 90100120 180, cash cost 606575 105, depreciation cost 252525 25, interest 555 5, pre tax income 0515 45, income tax 026 18, net operating cash flow 252834 52 =.

The net present value is 25 (1 + 14%) + 28 (1 + 14%) [2] + 34, (1 + 14%) [3] + (52-50) [4] (1) + 52-50 (1) + (52-50) = ($10000). According to MM theory in capital structure theory, the net present value of the project is divided into two parts: first, the net present value of all the capital needed for the project when it is made up of equity capital; and the present value of the asylum interest of debt tax.

In the previous example, the total cost of investment capital is equity capital, and the cost is 12%.

According to the net operating cash flow shown in Table 1, the first part of the net present value can be calculated as 110 thousand and 200 yuan [28 (1 + 12%) + 31 (1 + 12%) [2] + 37 ((1 + 12%) [3] + 55) (1 + 12%) [4] 100]. part of the debt is the present value of the tax liability's asylum interest.

The annual interest is 20 thousand yuan (5 x 40%) due to the interest payment of 50 thousand yuan per year, and the present value of the tax shield interest is 63 thousand and 400 yuan [2 + (1 + 10%) + 2 (1 + 10%) [2] + 10% ([3] + [4]).

Because the second part of the cash flow is the debt capital, the risk is the same as the debt capital risk, and it can be used as the interest of the debt capital interest rate.

By combining the first two parts, the net present value of the project is 11.02 + 6.34 = 17.36 (10000 yuan), and the net present value of the project is calculated from the investor's perspective.

The net cash flow per year is composed of two parts: first, the cash flow from equity capital investors; and the two is the cash flow from debt capital investors.

Since the interest of the debt tax is reflected in the cash flow from equity capital investors, the tax deduction function of interest should not be considered when calculating the weighted average capital cost.

According to the precedent, the net cash flow of equity capital investors from table 2 is 250 thousand yuan, 280 thousand yuan, 340 thousand yuan and 520 thousand yuan respectively, while debt capital investors earn net cash flow of 50 thousand yuan a year.

The net cash flow of equity capital and debt capital investors is 300 thousand yuan, 330 thousand yuan, 390 thousand yuan and 570 thousand yuan respectively.

The weighted average cost of capital is 50% x 14% + 50% x 10% = 12% net present value = 30 30 (1 + 12%) + 33 ((1 + 12%) [2] + 39) (1 + [3]) + [3] (+ +)).