Question

Lasik Vision Inc. recently analyzed the project whose cash flows are shown below. However, before Lasik decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected.

Old WACC:	8.00%		New WACC:	9.75%
Year	0	1	2	3
Cash flows	-$1,000	$410	$410	$410

a. -$34.12

b. -$32.50

c. -$28.60

d. -$30.55

e. -$29.25

Answer 1

Net Present Value of the Project at Old WACC of 8.00%

Year	Annual cash flows ($)	Present Value Factor (PVF) at 8.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	410	0.92593	379.63
2	410	0.85734	351.51
3	410	0.79383	325.47
TOTAL			1,056.61

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $1,056.61 - $1,000

= $56.61

Net Present Value of the Project at New WACC of 8.00%

Year	Annual cash flows ($)	Present Value Factor (PVF) at 9.75%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	410	0.91116	373.58
2	410	0.83022	340.39
3	410	0.75646	310.15
TOTAL			1,024.11

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $1,024.11 - $1,000

= $24.11

Change in Projects NPV

Change in Projects NPV = NPV at New WACC – NPV at Old WACC

= $24.11 - $56.61

= -$32.50 (Negative)

Therefore, the Change in Projects NPV is (b). -$32.50

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.