a) A project has an initial cost of $40,000, expected net cash inflows of $9,000
ID: 2732564 • Letter: A
Question
a) A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. What is the NPV of the project? (2.5 marks)
b) You are evaluating two 7-year projects both with a positive NPV at a WACC of 10%. One of the projects has all positive cash flows after year 0 and one has negative cash flows in years 0-3, positive cash flows in years 4-7 and a negative cash flow in year 8. If the WACC increased to 15% would you use the IRR or NPV method to evaluate the projects and why? (2.5 marks)
Explanation / Answer
a) NPV = $9000 * PVIFA (11%,7) - $40000 = $9000 * 4.712 - $40000 = $2408
b) If the WACC of the two evaluated projects increased from 10% to 15%, the use of NPV is better as the advantage to using the NPV method here is that NPV can handle multiple discount rates without any problems.
IRR does not account for changing discount rates or the cash flows vary year to year, so it's just not adequate for longer-term projects with discount rates that are expected to vary.
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