13. Last month, Lloyd\'s Systems analyzed the project whose cash flows are shown

Question

13. Last month, Lloyd's Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected.

Old WACC: 10.00% New WACC: 11.25%
Year 0 1 2 3
Cash flows - $1,000 $410 $410 $410

a. -$18.89
b. -$19.88
c. -$20.93
d. -$22.03
e. -$23.13

Explanation / Answer

NPV = CF0+CF1/(1+WACC)^1+CF2/(1+WACC)^2+CF3/(1+WACC)^3 WIth Old WACC = 10%, NPV(Old) = -1000+410/(1+10%)^1+410/(1+10%)^2+410/(1+10%)^3 = $19.61 WIth WACC = 11.25% NPV (New) = -1000+410/(1+11.25%)^1+410/(1+11.25%)^2+410/(1+11.25%)^3 = $(2.42) SO WACC has affected project's NPV by -2.42-19.61 = -$22.03 ...Ans(d)

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