Last month, Standard Systems analyzed the project whose cash flows are shown bel

Question

Last month, Standard 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 projects expected NPV can be negative, in which case it should be rejected. d WACC ear ash flows 10.00% 11.25% $1,000 $410 $410 $410

Explanation / Answer

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

At 10%:

Present value of inflows=$410[1-(1.1)^-3]/0.1

=$410*2.486851991

=$1019.61

NPV=Present value of inflows-Present value of outflows

=$1019.61-$1000

=$19.61(Approx)

At 11.25%:

Present value of inflows=$410[1-(1.1125)^-3]/0.1125

=$410*2.433128265

=$997.58

NPV=Present value of inflows-Present value of outflows

=$997.58-$1000

=($2.41)(Approx)(Negative)

Hence change in NPV=(2.41)-$19.61

=($22.03)(Approx)(Negative).

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