1.A firm is considering the following mutually exclusive projects: Project A Pro
ID: 2707128 • Letter: 1
Question
1.A firm is considering the following mutually exclusive projects:
Project A Project B
Year Cash Flow Cash Flow
0 -$5,000 -$5,000
1 200 3,000
2 800 3,000
3 3,000 800
4 5,000 200
At what cost of capital will the net present value of the two projects be the same? (That is, what is the
A firm is considering the following mutually exclusive projects: At what cost of capital will the net present value of the two projects be the same? (That is, what is the "crossover" rate?) The Seattle Corporation has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10 percent. What is the NPV for this investment? Now assume the Federal Reserve takes actions which increases interest rates and therefore impacts the firm's WACC. If the new WACC for Seattle Corporation becomes 14 percent By how much did the change in the WACC affect the project's forecasted NPV? That is, find the ?NPV resulting from the Federal Reserve actions.Explanation / Answer
1. NPV of project A = -5000+200/(1+r)+800/(1+r)^2 + 3000/(1+r)^3 + 5000/(1+r)^4
NPV of project B = -5000+3000/(1+r)+3000/(1+r)^2 + 800/(1+r)^3 + 200/(1+r)^4
Equating and solving, we get crossover rate = r = 16.15%
2. NPV (at WACC of 10%) = -150,000 + 30,000/1.1^1 + 30,000/1.1^2 + 30,000/1.1^3 + 30,000/1.1^4 + 35,000/1.1^5 + 35,000/1.1^6 + 35,000/1.1^7 + 35,000/1.1^8 + 35,000/1.1^9 + 40,000/1.1^10 = 51,138.24
New NPV (at WACC of 14%) = -150,000 + 30,000/1.14^1 + 30,000/1.14^2 + 30,000/1.14^3 + 30,000/1.14^4 + 35,000/1.14^5 + 35,000/1.14^6 + 35,000/1.14^7 + 35,000/1.14^8 + 35,000/1.14^9 + 40,000/1.14^10 = 19,344.21
So Change in NPV = 51,138.24 - 19,344.21 = 31,794.03, i.e. the NPV decreased by $ 31,794.03
Hope this helped ! Let me know in case of any queries.
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