It has been noted that the company’s gearing level has an implication for both the value of equity and the overall cost of capital. The viability of an investment project would depend partly on how it is financed and partly on how the method of financing affects the company’s gearing. Investment projects can be evaluated using NPV method by discounting the cash flows at the projects overall cost of capital or the risk adjusted discount rate. An alternative method of carrying out project appraisal is use of NPV method involving 2 stages:

Evaluate a project as if its an all equity financed to determine the base case NPV

Make adjustments to allow for the effect of the method of financing that has been used

APV = Base case NPV + PV of financing effect