Question

Please show me how to calculation with these question.

1. A company estimates that an average-risk project has a WACC of 12%, a below-average risk project has a WACC of 10%, and an above-average risk project has a WACC of 14%. Which of the following independent projects should the company accept?
   1. Project Y has below-average risk and an internal rate of return of 9%.  
   2. Project X has average risk and an internal rate of return of 11%.  
   3. Project Z has above-average risk and an internal rate of return of 15%.  
   4. All of the projects above should be accepted.

2. Consider an investment with an initial cost of $20,000 and is expected to last for 5 years. The expected cash flow in years 1 and 2 are $5,000, in years 3 and 4 are $5,500 and in year 5 is $1,000. The total cash inflow is expected to be $22,000 or an average of $4,400 per year.  Compute the payback period in years.

       A. 3.18 years                    B. 3.82 years

       C. 4.00 years                    D. 4.55 years

Answer 1

1) The correct answer is option 3 i.e. Project Z has above average risk and an internal rate of return of 15%

Project	Risk	WACC	IRR	Accept If IRR>WACC
X	Average Risk	12%	11%	Not Accept
Y	Below Average Risk	10%	9%	Not Accept
Z	Above Average Risk	14%	15%	Accept

The company should accept project Z

2) Computation of payback period

Year	Cashflows	Cummulative Cashflow
0	-20000
1	5000	5000
2	5000	10000
3	5500	15500
4	5500	21000
5	1000	22000

Payback period = 3 years + [(20000-15500)/5500]

Payback period = 3 + 0.82 years

Paybakc period = 3.82 years

The correct answer is option B i.e. 3.82 years

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