Asked by vaneeva perez on May 21, 2024
Verified
Westchester Corp.is considering two equally risky,mutually exclusive projects,both of which have normal cash flows.Project A has an IRR of 11%,while Project B's IRR is 14%.When the WACC is 8%,the projects have the same NPV.Given this information,which of the following statements is correct?
A) If the WACC is 13%, Project A's NPV will be higher than Project B's.
B) If the WACC is 9%, Project A's NPV will be higher than Project B's.
C) If the WACC is 6%, Project B's NPV will be higher than Project A's.
D) If the WACC is 9%, Project B's NPV will be higher than Project A's.
WACC
The Weighted Average Cost of Capital identifies the cost of a company's capital by weighting each capital category in proportion to its significance.
NPV
Net Present Value, a method used to evaluate the profitability of an investment by calculating the difference between the present value of cash inflows and outflows.
IRR
Internal Rate of Return; the discount rate that makes the net present value of all cash flows from a particular project equal to zero.
- Familiarize oneself with the fundamentals of mutually exclusive projects and how to make choices between them.
- Perceive the consequences of capital cost on the valuation of projects.
Verified Answer
MS
megan swartzMay 24, 2024
Final Answer :
D
Explanation :
When the WACC is 8%, the projects have the same NPV, which means the projects' cash inflows equal the cash outflows, and the sum of the present value of all cash inflows equals the sum of the present value of all cash outflows.
At WACC of 9%, the NPV of Project A will decrease, while the NPV of Project B will increase. Project B has a higher IRR, which means it will generate more cash inflow per dollar invested than Project A. Thus, Project B's cash flows are relatively more significant at a higher discount rate, and its NPV will increase more than Project A's NPV decreases. Therefore, Project B will have a higher NPV at WACC of 9%.
Therefore, the correct answer is D) If the WACC is 9%, Project B's NPV will be higher than Project A's.
At WACC of 9%, the NPV of Project A will decrease, while the NPV of Project B will increase. Project B has a higher IRR, which means it will generate more cash inflow per dollar invested than Project A. Thus, Project B's cash flows are relatively more significant at a higher discount rate, and its NPV will increase more than Project A's NPV decreases. Therefore, Project B will have a higher NPV at WACC of 9%.
Therefore, the correct answer is D) If the WACC is 9%, Project B's NPV will be higher than Project A's.
Learning Objectives
- Familiarize oneself with the fundamentals of mutually exclusive projects and how to make choices between them.
- Perceive the consequences of capital cost on the valuation of projects.