Suppose you are considering a project that is expected to generate Net Cash Flow
ID: 2651964 • Letter: S
Question
Suppose you are considering a project that is expected to generate Net Cash Flows of $175,000 in each of the first 8 years, and then $250,000 in the last 12 years (20 years in total). You are considering two different capital structures for funding the project. The first option (OPTION A) has a WACC of 6.5%, while the second (OPTION B) has a WACC of 8.2%.
Which capital structure is better and by how much? Show by comparing Net Present Values (NPV).
Better Option ________________
By how much? ________________
Explanation / Answer
Year
Cash Flow
PVAF/ PVIF @ 6.5 %
NPV @ 6.5 %
PVAF/ PVIF @ 8.2 %
NPV @ 8.2 %
1-8
175,000
6.089
1065531.42
5.703
998073.68
9
250,000
0.567
141838.31
0.492
122997.04
10
250,000
0.533
133181.51
0.455
113675.64
11
250,000
0.500
125053.06
0.420
105060.66
12
250,000
0.470
117420.71
0.388
97098.58
13
250,000
0.441
110254.19
0.359
89739.91
14
250,000
0.414
103525.06
0.332
82938.92
15
250,000
0.389
97206.63
0.307
76653.34
16
250,000
0.365
91273.83
0.283
70844.12
17
250,000
0.343
85703.13
0.262
65475.16
18
250,000
0.322
80472.42
0.242
60513.09
19
250,000
0.302
75560.96
0.224
55927.07
20
250,000
0.284
70949.26
0.207
51688.60
Total
2,297,970.49
1,990,685.81
PVAF= [(1+i)n-1]/ ‘i x (1+i)n
PVIF= (1+i)-n
Conclusion- As NPV is higher in option A when WACC is 6.5 % , hence Option A is better option
Option A provide $ 307,284.68 provide more cash flow in terms of net present value compare to option B.
Year
Cash Flow
PVAF/ PVIF @ 6.5 %
NPV @ 6.5 %
PVAF/ PVIF @ 8.2 %
NPV @ 8.2 %
1-8
175,000
6.089
1065531.42
5.703
998073.68
9
250,000
0.567
141838.31
0.492
122997.04
10
250,000
0.533
133181.51
0.455
113675.64
11
250,000
0.500
125053.06
0.420
105060.66
12
250,000
0.470
117420.71
0.388
97098.58
13
250,000
0.441
110254.19
0.359
89739.91
14
250,000
0.414
103525.06
0.332
82938.92
15
250,000
0.389
97206.63
0.307
76653.34
16
250,000
0.365
91273.83
0.283
70844.12
17
250,000
0.343
85703.13
0.262
65475.16
18
250,000
0.322
80472.42
0.242
60513.09
19
250,000
0.302
75560.96
0.224
55927.07
20
250,000
0.284
70949.26
0.207
51688.60
Total
2,297,970.49
1,990,685.81
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