Question

1. It is a capital budgeting problem. Assume that XYZ company wants to invest in a new project that needs $2.65 billion (time 0). It is expected that it will give cash flows as given below.

Year 0	Year 1	Year 2	Year 3	Year 4	Year 5-10	Year 11	Year 12-14	Year 15
2,650 million	0 million	0 million	100 million	200 million	550 million	400 million	200 million	50 million

Find the NPV and IRR of the project. Should you accept the project? Discuss in details why you accept or reject the project. Assume WACC is 10%.

2. If the firm wants to reduce its WACC (from 10% to 8%), how should the company do it? (think about it, I am not helping in this question).

Answer 1

Solution:

The NPV can be calculated by discounting the future cash flow with the given discount rate of 10%.

When WACC is 10%

• The NPV is -$475.69 million and IRR is 7.21%
• The project should be rejected as the NPV is negative and IRR is less than WACC

When WACC is 8%

• Since IRR is 7.21%, which is less than WACC of 8% hence the NPV will be negative and the project is not acceptable even if WACC is 8%. The NPV is -$146.37 million