Question

Given that company X has a policy of risk adjusting their WACC of 12% by plus or minus 3% for above and below average risk projects respectively, which of the following independent projects are accepted using NPV?

Project: A B C

Risk: Average Below Above

CF0 -10 -20 -25

CF1 5 10 5

CF2 5 10 5

CF3 4 7 10

CF4 4 3 20

Go / No Go Go / No Go Go / No Go

NPV ________ ________ ________

Please give thorough explanation and step by step instruction. Very important to learn this one!

Answer 1

PROJECT A:
Year	Cash Flow	PVIFA at 12%	PV at 12%
0	$ -10.00	1.00000	$ -10.00
1	$               5.00	0.89286	$                4.46
2	$               5.00	0.79719	$                3.99
3	$               4.00	0.71178	$                2.85
4	$               4.00	0.63552	$                2.54
NPV			$                3.84
The project has average risk and hence the discount rate is the WACC = 12%
PROJECT B:
Year	Cash Flow	PVIFA at 9%	PV at 9%
0	$           -20.00	1.00000	$ -20.00			`
1	$            10.00	0.91743	$                9.17
2	$            10.00	0.84168	$                8.42
3	$               7.00	0.77218	$                5.41
4	$               3.00	0.70843	$                2.13
NPV			$                5.12
The project has below average risk and hence the discount rate is the WACC = 12%-3% = 9%
PROJECT C:
Year	Cash Flow	PVIFA at 15%	PV at 15%
0	$           -25.00	1.00000	$ -25.00			`
1	$ 5.00	0.86957	$                4.35
2	$ 5.00	0.75614	$                3.78
3	$            10.00	0.65752	$                6.58
4	$            20.00	0.57175	$ 11.44
NPV			$                1.14
The project has above average risk and hence the discount rate is the WACC = 12%+3% = 15%
DECISION:
As all the three projects have positive NPVs, all of them can be accepted.