Question

Problem Two You are considering two mutually exclusive projects with the following cash flows: (Please show calculations)

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?

Please show calculations

Answer 1

B. Primarily the WACC depends upon the capital structure of debt and equity in a firm. Lower the WACC of a firm wider the scope for acceptance of more number of projects because a firm having lower WACC can accept projects with a lower cash flow and still have positive NPV. as we see in current situation the initial cash flow of project A is lower and is having increasing cash flow in time and has a higher WACC whereas the project B has a higher initial cost and constant cash flow IIs giving almost same NPV with a lower WACC.