Question

Last month, Lloyd's Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project took place, the Federal Reserve 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 expected NPV can be negative, in which case it should be rejected. -$22.03 Old WACC: 10.00% New WACC: 11.25% Year 0 1 2 3 Cash flows -$1,000 $410 $410 $410

OLD NPV $19.61

NEW NPV -2.42

CHANGE in NPV= 19.61-2.42= -22.03

The steps for 10.00%

Old WACC = 10.00%,
(410)/(1.10)=372.73

410/(1.10)^2=338.84

Year 3=

1.1, yx, 3=1.331

410/1.331=308.04

308.04+338.84+372.73-1000=19.61

What are the steps for 11.25%?

Please do not use Excel!

Answer 1

APPROACH 1:

The steps for 11.25%

New WACC = 11.25%,

Year 1=(410)/(1.1125)=368.54

Year 2=410/(1.1125)^2=331.27

Year 3=410/(1.1125)^3=297.77

NPV=368.54+331.27+297.77-1000=-2.42

APPROACH 2:

OLD NPV
Using financial calculator
press CF 2nd CE/C
press CF
-1000
Enter
down arrow,
410
Enter
down arrow (twice),
410
Enter
down arrow (twice),
410
Enter
down arrow (twice)

press NPV
Type 10
Enter
press down arrow
press CPT
=19.61

NEW NPV
Using financial calculator
press CF 2nd CE/C
press CF
-1000
Enter
down arrow,
410
Enter
down arrow (twice),
410
Enter
down arrow (twice),
410
Enter
down arrow (twice)

press NPV
Type 11.25
Enter
press down arrow
press CPT
=-2.42

Change=-2.42-19.61=-22.03