The cash flows of another project with a missing initial cost are as follows: 2

Question

The cash flows of another project with a missing initial cost are as follows: 2 $400 $800 $500 $300 The project has the same risk as the firm's average project. While you don't know the project's initial cost, you have been told the project has an IRR of 13.3703%. Your boss wants to accept the project because the project's IRR exceeds the WACC of 12.6%, but another manager has mentioned that the NPV should be considered. How much value does this project create for the firm? O $66.50 O $35.28 O $60.18 O $23.07 $23.07 O $17.03

Explanation / Answer

Solution:

$23.07.

Present Value = [C1 / (1+r)1] + [C2 / (1+r)2] + ... + [Cn / (1+r)n]

where,

Ci = Cashflow in period i (i=1, 2, 3.. n)

r = rate of interest / discount rate,

n = number of periods.

Present Value (IRR) = [400/(1+13.3703%)1] + [800/(1+13.3703%)2] +[500/(1+13.3703%)3] + [300/(1+13.3703%)4]

                             = $1,500.

Present Value (WACC) = [400/(1+12.6%)1] + [800/(1+12.6%)2] +[500/(1+12.6%)3] + [300/(1+12.6%)4]

                                  = $1,523.07

Value Created for the Firm = Net Present Value = Present Value (WACC) - Present Value (IRR)

Net Present Value = $1,523.07 - $1,500 = $23.07.

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