A company has a 13% WACC. One of its core divisions is considering two mutually exclusive investments with the net cash flows given below. The division’s beta is βDIV = 1.45, risk free rate is kRF = 6.8% and risk-premium on the market is RPM =7% Year Project A project B 0 -$1000 -$1000 1 $200 $800 2 $700 $600 3 $600 $250 4 $800 $150 5 -$300 $170 6 $250 $150 Given the information above, you are required to answer the followings: i. What is each project’s Payback and discounted payback periods and interpret these numbers? ii. What is each project’s NPV? iii. What is each project’s IRR?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
A company has a 13% WACC. One of its core divisions is considering two mutually
exclusive investments with the net cash flows given below. The division’s beta is βDIV
= 1.45, risk free rate is kRF = 6.8% and risk-premium on the market is RPM =7%
| Year | Project A | project B |
| 0 | -$1000 | -$1000 |
| 1 | $200 | $800 |
| 2 | $700 | $600 |
| 3 | $600 | $250 |
| 4 | $800 | $150 |
| 5 | -$300 | $170 |
| 6 | $250 | $150 |
Given the information above, you are required to answer the followings:
i. What is each project’s Payback and discounted payback periods and interpret
these numbers?
ii. What is each project’s
iii. What is each project’s
iv. What is each project’s MIRR?
v. From your answers to Parts a, b, c and d, which project would be selected?
vi. What is each project’s profitability index?
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