Wren Manufacturing is in the process of analyzing its investment decision-making
ID: 2659231 • Letter: W
Question
Wren Manufacturing is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm during the past month were projects 263 and 264. The basic variables surrounding each project analysis and the resulting decision actions are summarized in the following table.
Basic variables Project 263 Project 264
Cost $64,000 $58,000
Life 15 years 15 years
Expected return 8% 15%
Least-cost financing
Source Debt Equity
Cost (after-tax) 7% 16%
Decision
Action Invest Don
Explanation / Answer
A) The firms decision-making procedures are not ideal because they consider financing for each project independent of the firms overall financing. So to accept project 263 will destroy wealth whereas rejecting project 264 is a missed opportunity to create wealth.
B) Weighted average cost of capital (WACC) = Wd * Rd + We * Re = 0.40 * 7% + 0.6* 16% = 2.8% + 9.6% = 12.4%
C) If the firm had used the WACC they would have rejected project 263 and accepted 264.
D) The findings are direct opposites. Using the WACC method is more appropriate since it is the firms overall cost of capital and not just the individual projects cost of capital. The firm in this case has cheaper overall financing than for project 264 making the project profitable whereas their overall cost would make project 263 a non-profitable project.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.