ORCID
Paweł Mielcarz: 0000-0002-3986-1858
Dmytro Osiichuk: 0000-0002-6235-2576
Adrian Struciński: 0009-0005-6834-2853
Keywords
capital budgeting, cost of capital, project finance
Abstract
The paper aims at elucidating and solving the methodological problems around the estimation of the cost of capital in the project finance settings. By convention, capital budgeting analysts evaluate project finance ventures using the free cash flow for equity (FCFE) method, whereby cash flows, including cash, whose distribution is limited by debt covenants, are discounted with the project’s cost of equity. We argue that this approach is erroneous. From the standpoint of the sponsor company, only distributable cash flows should be taken into consideration when evaluating project finance ventures. In turn, the discount rate should be equal to the weighted average cost of capital of the sponsor, which should reflect the financing of the venture from the sponsor’s capital mix. In the case of full recourse to the sponsor, the WACC of the sponsor needs to be adjusted to reflect the change in capital structure as a result of shifting the credit risk to the sponsor’s balance sheet. Failure to adhere to the guidelines outlined in this paper may lead to the undervaluation of investment projects and suboptimal allocation of investment budgets, particularly in large corporations that use their capital invested to inject equity into subsidiary SPVs.
Acknowledgments
Funding
The research received no funds.
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect to the research, authorship, and publication of the article.
Declaration about the scope of AI utilization
The authors did not use an AI tool in the preparation of the article.
Recommended Citation
Mielcarz, P., Osiichuk, D., & Struciński, A. (2025). The Cost of Capital Calculation in the Project Finance Settings. Journal of Banking and Financial Economics, 2025(2), 60-75. https://doi.org/10.7172/2353-6845.jbfe.2025.2.4
First Page
60
Last Page
75
Page Count
26
Received Date
19.02.2025
Revised Date
21.07.2025
Accept Date
21.07.2025
Online Available Date
29.08.2025
DOI
10.7172/2353-6845.jbfe.2025.2.4
JEL Code
G30; G32
Publisher
University of Warsaw
