Thanks Fairfax Pizza has a weighted-average cost of capital of 10.3 percent and

Question

Thanks Fairfax Pizza has a weighted-average cost of capital of 10.3 percent and is evaluating two projects A & B. What is The NPV of project A plus the NPV of project B? Project A has an initial investment of 6,874 dollars today and an expected cash flow of 12,579 dollars in 8 years. Project A is considered more risky than an average-risk project at Fairfax Pizza, such that the appropriate discount rate for it is 0.85 percentage points different than the discount rate used for an average-risk project at Fairfx-Pizza. The internal rate of return for project A is 7.846 percent. Project B has an initial investment of 4.722 dollars today and an expected cash flow of 7.366 dollars in 7 years. Project B is considered less risky than an average-risk project at Fairfax Pizza such that the appropriate discount rate for it is 1.91 percentage points different than the discount rate used for an average-risk project at Fairfax Pizza. The internal rate of return for project B is 6.558 percent.

Explanation / Answer

Required rate project A = average WACC+premium = 10.3+0.85 = 11.15%

Required rate project B = average WACC-discount = 10.3-1.91 = 8.39%

Project A NPV

Project B NPV

Total NPV =

Discount rate 11.150% Year 0 1 2 3 4 5 6 7 8 Cash flow stream -6874 0 0 0 0 0 0 0 12579 Discounting factor 1 1.1115 1.235432 1.373183 1.526293 1.696474 1.885631 2.095879 2.32957 Discounted cash flows project -6874 0 0 0 0 0 0 0 5399.709 NPV = Sum of discounted cash flows NPV = -1474.29 Discounting factor = (1 + discount rate)^(CORRESPONDING PERIOD IN YEARS) Discounted Cashflow= Cash flow stream/discounting factor

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