Project valuation

1. NPV and shareholders’ wealth inverse relationship

Selecting project with a higher NPV essentially means operating with a lower WACC, implying a
high level of debt (up to a certain proportion) which would entail higher interest payments. This
increased outflow of cash means a smaller quantity is added back to shareholders’ wealth, i.e.
retained earnings and hence retained earnings grow at a slower pace.

In essence, selecting a project with a higher NPV is leading to a negative effect on shareholders’
wealth which we think is contrary to the general available literature.

2. An alternate to using CAPM for calculating cost of equity in WACC

Although beta in theory, tries to capture a company’s intrinsic attributes but for this it assumes
EMH to operate. However, this assumption doesn’t hold true for most of the cases and hence a
beta coefficient should be introduced which takes into consideration company specific
fundamental factors especially the ones related to the level of debt.