V-Sport management team is considering two projects, a golf club project and a helmet project.
WACC = 9.3%
V-Sport:
% of debt in capital structure 25%
% of equity in capital structure 75%
Before-tax required cost of debt 6%
Tax rate 30%
Cost of equity 11%
B. Capital Budgeting
Project information:
Golf club project Helmet project
Upfront costs (10,000,000) (8,000,000)
Annual cash flows Year 1 $0 $3,000,000
Year 2 $0 $3,000,000
Year 3 $4,000,000 $2,000,000
Year 4 $10,000,000 $2,000,000
IRR = Golf club = 9.51%
IRR = Helmet = 10.47%
NPV with WACC as discount rate
Golf club = 70164.4
Helmet = 188981.1
Question 1: The data provided above does not contain any measure of the riskiness of the projects. What are two ways that we could adjust the analysis if it were determined that the golf club project was a much riskier project whose cash flow projections were much more uncertain?
Question 2: What specific information would the management team need to gather if they wanted to consider the relative riskiness in terms of the “portfolio effect”?