In: Finance
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 |
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At 8%:
Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)
=410/1.08+410/1.08^2+410/1.08^3
=1056.61
NPV=Present value of inflows-Present value of outflows
=1056.61-1000
=$56.61(Approx)
At 9.75%:
Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)
=410/1.0975+410/1.0975^2+410/1.0975^3
=1024.11
NPV=Present value of inflows-Present value of outflows
=1024.11-1000
=$24.11(Approx)
Hence change in NPV=24.11-56.61
=$-32.50(Approx)(Negative)