Question

NPV Your division is considering two projects with the following cash flows (in millions): 0 1 2 3 Project A -$17 $8 $8 $3 Project B -$26 $13 $10 $9 What are the projects' NPVs assuming the WACC is 5%? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Project A $ million Project B $ million What are the projects' NPVs assuming the WACC is 10%? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Project A $ million Project B $ million What are the projects' NPVs assuming the WACC is 15%? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Project A $ million Project B $ million What are the projects' IRRs assuming the WACC is 5%? Round your answer to two decimal places. Project A % Project B % What are the projects' IRRs assuming the WACC is 10%? Round your answer to two decimal places. Project A % Project B % What are the projects' IRRs assuming the WACC is 15%? Round your answer to two decimal places. Project A % Project B % If the WACC were 5% and A and B were mutually exclusive, which would you choose? (Hint: The crossover rate is 20.19%.) If the WACC were 10% and A and B were mutually exclusive, which would you choose? (Hint: The crossover rate is 20.19%.) If the WACC were 15% and A and B were mutually exclusive, which would you choose? (Hint: The crossover rate is 20.19%.)

Answer 1

A) Computation of NPV of project A and project B:

NPV = Net present value of all future generated cash inflow - initial investment.

Net present value of all future cash flow =

1) when WACC is 5%:

Project A =

= 7.619047619 +7.256235828 +2.591512796 - 17

= 0.47

Project B =

=12.38095238+9.070294785+7.774538387-26

=29.22578862 -26

=3.23

2) when WACC is 10%

Project A :

NPV =

= 7.272727273+6.611570248+2.253944403-17

=16.13824195-17

=-0.86

Project B :

NPV=

= 11.81818182 + 8.26446281 +6.761833208 -26

= 0.84

3) when WACC is 15%

Project A:

NPV =

= 6.956521739 +6.049149338 + 1.972548697 - 17

= 14.97821977 -17

= -2.02

Project B:

NPV =

= 11.30434783 + 7.561436673 +5.917646092 -26

= -1.21

B) Internal Rtae of Return:

IRR = that state which equates the NPV of cash inflows with the initial investment.

therefore, Future cash inflows ( PVFn)= Initial Investment

computation of IRR:

Project A :

IRR = (8+8+3)(PVFn) = 17

(PVFn)=17/20

(PVFn)=0.85

The discounting rate of 5% for 3 years is 0.8638 and at 6 % its 0.8396

hence IRR for the project is

= 5.570%

Project B: (10+10+9) (PVFn)= 26

(PVFn)=26/29

(PVFn)=0.896551724

(PVFn) at the rate 3% for 2 year is 0.9151 and at the rate of 4% it is 0.8890

hence IRR=3.7088%

General Rule of acceptance:

If IRR > WACC - Accept the proposal

if IRR< WACC - Reject the proposal

1) when WACC is 5%

Project A - Accept the project since 5.57% is more than the WACC

Project B- Reject the project since 3.7088% as compaired to the weighted average cost to the firm.

2) when WACC is 10%

Project A - though IRR is less but it is more than project B hence should be given prefference

Project B- should not be accepted

3) when WACC os 15%

Project A - though IRR is less but it is more than project B hence should be given prefference

Project B - should not be accepted.