Question 1: Last month, Lloyd's 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 -$1000 $410 $410 $410
Question 2: A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose?
Year 0 1 2 3 4
CFS -$1,025 $380 $380 $380 $380
CFL -$2,150 $765 $765 $765 $765
Question 3: Yonan Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost.
Year 0 1 2 3 4
CFS -$950 $500 $800 $0 $0
CFL -$2,100 $400 $800 $800 $1,000