Last month, Standard Systems analyzed the project whose cash flows are shown bel

Question

Last month, Standard Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project took place, the Federal Reserve 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 expected 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 (respectively) Do not round intermediate calculaitons

a. -$19.88

b. -$20.93

c. -$23.13

d. -$22.03

e. -$18.89

Explanation / Answer

d.- $22.03.

the following table shows it:

change in NPV = - $2.42 - $19.61 => - $22.03

note:

present value of annuity factor = [ 1- (1+r)^(-n)] /r

since we have equal annula cash flows of $410 in each of the 3 years, their present value can be found out using present value annuity factor.

@10%

=> [ 1 - (1.10)^(-3)]/0.10

=>[ 1 - 0.7513148]/0.10

=>0.2486852/0.10

=>2.486852

@11.25%

[1 -(1.1125)^(-3)]/0.1125

=>[1-0.72627307] / 0.1125

=>0.2737269 / 0.1125

=>2.433128

year Cash flow discouting factor @10% discounted cash flow @10% discount factor at 11.25% discounted cash flow @11.25% 0 - $1,000 1 -$1000 1 -$1000 1 - 3 $410 2.486852 (see note) 1,019.61 2.433128 (see note) $997.58 NPV $19.61 - $2.42

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