Fairfax Pizza has a weighted-average cost of capital of 10.77 percent and is eva

Question

Fairfax Pizza has a weighted-average cost of capital of 10.77 percent and is evaluating two projects: A and B. Project A has an initial investment of 4,345 dollars today and an expected cash flow of 6,604 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 1.06 percentage points different than the discount rate used for an average-risk project at Fairfax Pizza. The internal rate of return for project A is 5.372 percent. Project B has an initial investment of 5,594 dollars today and an expected cash flow of 8,894 dollars in 3 years. Project B is considered less risky than an average-risk project at Fairfax Pizza, such that the appropriate discount rate for it is 1.19 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 16.715 percent. What is The NPV of project A plus the NPV of project B?

Explanation / Answer

project A

discount rate = 10.77% + 1.06% = 11.83%

NPV = -4345 + 6604/(1+11.83%)8 = -1645.14

project B

discount rate = 10.77% - 1.19% = 9.58%

NPV = -5594+ 8894/(1+9.58%)3 = 1165.32

Total NPV = -1645.14 + 1165.32 = -479.82

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