10-5
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.
Question 11-4
What is a mutually exclusive project? How should managers rank mutually exclusive projects
11-1
NPV Project L costs $65,000, its expected cash inflows are $12,000 per year for 9 years, and its WACC is 9%. What is the project’s NPV?
11-2
IRR Refer to question 11-1. What is the project’s IRR?
11-6
NPV Your division is considering two projects with the following cash flows (in millions):
0 1 2 3
Project A -$25 $5 $10 $17
Project B -$20 $10 $9 $6
a. What are the projects’ NPVs assuming the WACC is 5%? 10%? 15%? b. What are the projects’ IRRs at each of these WACCs? c. If the WACC was 5% and A and B were mutually exclusive, which project would you
choose? What if the WACC was 10%? 15%? (Hint: The crossover rate is 7.81%.)
11-12
IRR AND NPV A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:
0 1 2 3 4
Project S -$1,000 $870 $250 $25 $25
Project L -$1,000 $0 $250 $400 $845
The company’s WACC is 8.5%. What is the IRR of the better project? (Hint: The better project may or may not be the one with the higher IRR.)
