Question

Assume that you are a new analyst hired to evaluate the capital budgeting projects of the company which is considering investing in two CPEC projects, “Expansion Zone North” and “Expansion Zone East”. The initial cost of each project is Rs. 10,000. Company discount all projects based on WACC. Further, all the projects are equally risky projects and the company uses only debt and common equity for financing these projects. It can borrow unlimited amounts at an interest rate of rd 10% as long as it finances at its target capital structure, which calls for 50% debt and 50% common equity. The dividend for next period is $2.0, its expected that they will grow at the constant growth rate of 8%, and the company’s common stock sells for $20. The tax rate is 50%.

The cash flows of both the projects are given in table below:

Time Expansion Zone North
Cashflows (amount in Rs.) Expansion Zone East
Cashflows (amount in Rs.)
0 - 10,000 - 10,000
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500

Carefully analyze the above table and answer the following questions in detail.
I. Calculate the weighted average cost of capital for this firm? (2.5 marks)
II. Compute each project’s IRR, NPV, payback, MIRR, and discounted payback. (2.5 Marks)
III. Which project(s) should be accepted if they are mutually exclusive? Explain (1.5 Marks)
IV. Which project(s) should be accepted if they are independent? Explain (1.5 Marks)

Answer 1

Answer:

i. Determination of WACC:

To calculate the WACC, we need to calculate the cost of equity initially.

Now determine the WACC,

Hence, the WACC is 11.90%.

ii. Determination of IRR, NPV, Payback, MIRR and Discounted Payback:

iii.

Since Expansion Zone North has a higher NPV compared to Expansion Zone East if they are mutually exclusive, hence Expansion Zone North should be chosen.

iv.

Since both the projects have positive NPV, IRR and MIRR greater than cost of capital, payback period and discounted payback of less than 4 years, both the projects can be accepted if they are independent, hence Both Projects can be chosen.

NOTE: The answers for Part II is highlighted in BOLD in the Excel.