Fundamentals of Financial Manageme...
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Fundamentals of Financial Manageme...
PROJECT SELECTION Midwest Water Works estimates that its WACC is 10.5%. The company is considering the following capital budgeting projects:
| Project | Size | Rate of Return |
| A | $1 million. | 12.0% |
| B | 2 million | 11.5 |
| c | 2 million | 11.2 |
| D | 2 million | 11.0 |
| E | 1 million | 10.7 |
| F | 1 million | 10.3 |
| G | 1 million | 10.2 |
Assume that each of these projects is just as risky as the firm’s existing assets and that the firm may accept all the projects or only some of them Which set of projects should be accepted? Explain.
To identify: The set of projects that should be accepted with reasons.
Introduction:
Weighted Average Cost of Capital (WACC):
It is the weighted average cost of all the source through which the firm finances its capital. It is the rate that a company will pay to all for raising finance. It can be termed as the firm’s cost of capital. The company raises money through various sources such as common stock and preference share debt. The WACC is calculated by taking the relative weight of each item of the capital structure.
The formula to calculate WACC is,
Where,
Internal Rate of Return (IRR):
It is defined as the discount rate that determines the return that an investor expects from a project. IRR occurs at the breakeven point that is when the net present value (NPV) is zero. It helps in decision making while accepting the project. When IRR is more than the cost of capital/WACC, the project is recommended to be accepted.
The projects which have the higher return than WACC should be accepted. The project A, B, C, D and E has higher return than WACC. So these projects should be accepted.
The WACC of the company is 10.5 %. Thus the project which has a higher return than 10...
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