Only firms with no debt in their capital structure should use the cost of equity to discount project cash flows, and only those projects that are very similar to a firm’s exiting assets should be discounted using that rate.

Firms with both debt and equity should use the WACC as long as they are evaluating a project that is similar to their existing assets. In part (a) we were asked to calculate the cost of capital that APP sold use as a discount rate when appraising new marginal investment opportunities. In this case the original WACC of 7.85% is appropriate.

When a firm is making an investment that is very different from its existing investments, then it shouldn’t use the company’s cost of equity or it’s WACC. Similarly if a firm is considering major investment that is expected to change its operating and financial leverage, then it shouldn’t use the company’s cost of equity or it’s WACC.