Question

Reddington Enterprises is considering two capital Budget projects with the following cashflows at a WACC of 12%. At what rates do these projects have the same NPV?

  Red Wine Vineyards Kaplan Cleaners

0 -200,000 -200,000

1 50,000 175,000

2 125,000 125,000

3 200,000 100,000

4 300,000 75,000

Answer choices:

A. 12.0%

B. 43.4%

C. 19.5%

D. 25.7%

E. 32.8%

Answer 1

Let both project will have same NPV at i%

Red Wine Vineyards:

Cash Flows:
Year 0 = -$200,000
Year 1 = $50,000
Year 2 = $125,000
Year 3 = $200,000
Year 4 = $300,000

NPV = -$200,000 + $50,000/(1+i) + $125,000/(1+i)^2 + $200,000/(1+i)^3 + $300,000/(1+i)^4

Kaplan Cleaners:

Cash Flows:
Year 0 = -$200,000
Year 1 = $175,000
Year 2 = $125,000
Year 3 = $100,000
Year 4 = $75,000

NPV = -$200,000 + $175,000/(1+i) + $125,000/(1+i)^2 + $100,000/(1+i)^3 + $75,000/(1+i)^4

NPV of Red Wine Vineyards = NPV of Kaplan Cleaners
-$200,000 + $50,000/(1+i) + $125,000/(1+i)^2 + $200,000/(1+i)^3 + $300,000/(1+i)^4 = -$200,000 + $175,000/(1+i) + $125,000/(1+i)^2 + $100,000/(1+i)^3 + $75,000/(1+i)^4
0 = -$125,000/(1+i) + $0/(1+i)^2 + $100,000/(1+i)^3 + $225,000/(1+i)^4
0 = -$125,000 + $0/(1+i) + $100,000/(1+i)^2 + $225,000/(1+i)^3

Using financial calculator, i = 43.4%

So, both projects will have same NPV at 43.4%