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 cost of capital (r). The Fed's action did not affect the forecasted cash flows. By how much did the change in the r affect the project's forecasted NPV? Note that a project's expected NPV can be negative, in which case it should be rejected.

11.25%

0

1

2

3

?$1,000

$410

$410

$410

11.25%

0

1

2

3

?$1,000

$410

$410

$410

Explanation / Answer

NPV = Present value of cash inflows - present value of cash outflows

NPV when WACC is 10%:

NPV = -1000 + 410 / ( 1 + 0.1)1 + 410 / ( 1 + 0.1)2 + 410 / ( 1 + 0.1)3

NPV = 19.6093

NPV when WACC is 11.25%:

NPV = -1000 + 410 / ( 1 + 0.1125)1 + 410 / ( 1 + 0.1125)2 + 410 / ( 1 + 0.1125)3

NPV = -2.4174

Change in NPV = 19.6093 + 2.4174

Change in NPV = 22.03

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