Question 1: A company is considering a project that produces the following cash flows
|
End of Year
|
Cash Flows
|
|
0
|
-$150,000
|
|
1
|
$40,000
|
|
2
|
$40,000
|
|
3
|
$40,000
|
|
4
|
$20,000
|
|
5
|
$20,000
|
|
6
|
$20,000
|
|
7
|
$10,000
|
|
8
|
$10,000
|
Assume that the appropriate discount rate for this project is 8%.
a) Compute the IRR of this project.
b) Compute the NPV of this project.
c) To select a project would you use IRR or NPV? Explain.
d) What is the economic interpretation of IRR and NPV?
Question 2: The AI corporation has a $150 M worth of common stock on which investors require a 17% rate of return. It also has $35 M in bonds that offer a 7% return.
a) Compute the WACC assuming that AI is subject to a 40% tax rate.
b) Re-compute the WACC assuming that the firm has $85 M in debt and $100 M in stock.
c) Explain why the WACC computed in b) may not be the correct answer if the capital structure changes.