Question

Problem Two You are considering two mutually exclusive projects with the following cash flows:

Project C/F0 C/F1 C/F2 C/F3 C/F4 C/F5 C/F6

A $(41,215) $12,500 $14,000 $16,500 $18,000 $20,000 N/A

B $(46,775) $15,000 $15,000 $15,000 $15,000 $15,000 $15,000

A) Assuming that the discount rate for project A is 16% and the discount rate for B is 15%, then given that these are mutually exclusive projects, which project would you take and why?

B) If you are one of the management teams, when making a capital budgeting decision, how would you explain why the WACC is different for project A than for project B?

Answer 1

B. Primarily reason for a different WACC of project A than project B is that it could be having a different set of capital structure of debt and equity. Lower the WACC, higher will be the valuations of the company and vice versa. Lower WACC also widens the scope of the company by allowing it to accept low return projects and still create value. But In present case as we see initial cost of project A is lower and it's giving a increasing NPV in time where as in project B the initial cost is higher and the cash flow is fixed even though it's creating almost same cash flow with a minor difference.