Question

11.7

Apply WACC in

NPV.

  Brawn Blenders has the following incremental cash flow for its new​ project:

Category	T0		T1	T2	T3
Investment	−​$3,565,000
Net working capital change	−​$281,000				​$281,000
Operating cash flow			​$1,182,000	​$1,182,000	​$1,182,000
Salvage					​$269,000

Should Brawn accept or reject this project at an adjusted WACC of

a. 8.11​%,

b. 10.11​%,

c. 12.11​%?

Answer 1

Should Brawn accept or reject this project at an adjusted WACC of

A) 8.11%

Answer: Project should be rejected. (Since NPV is Negative (i.e. NPV less than zero) project should be rejected). NPV = -$370,630.93.

B) 10.11%

Answer: Project should be rejected. (Since NPV is Negative (i.e. NPV less than zero) project should be rejected). NPV = -$500,238.11

C) 12.11%

Answer: Project should be rejected. (Since NPV is Negative (i.e. NPV less than zero) project should be rejected). NPV = -$622,065.23

Workings

Formula for calculating Net Present Value is as follows

NPV     = Present Value of Future cash flows – Initial investment

Initial investment           = Investment + Net working capital change

Present value of future cash flows: is the total of present value of all future cash flows. Present value of a cash flow can be found out using the following formula.

Present Value = Cash flow = (1+ R)N

Where,

R = required rate of return

N = number of years

Calculation of NPV when WACC is 8.11%

Initial investment           = Investment + Net working capital change

                                    = $3,565,000 + $281,000

                                    = $3,846,000

Present value of future cash flows calculation

Present Value = Cash flow = (1+ R)N

Year	Cash Flow	Workings for present Value	Present Value
1	$1,182,000	=$1,182,000 ÷(1.0811)1	$1,093,330.87
2	$1,182,000	=$1,182,000 ÷(1.0811)2	$1,011,313.35
3	$1,732,000	=$1,732,000 ÷(1.0811)3	$1,370,724.85
	Present value of future cash flows	$3,475,369.07

(Note: cash flow of Year 3 is the sum total of recovery of working capital of $281,000., Operating cash flow of $1,182,000. and salvage value of $269,000.)

NPV Calculation

NPV     = Present Value of Future cash flows – Initial investment

                =$3,475,369.07 -   $3,846,000

            = -$370,630.93

Calculation of NPV when WACC is 10.11%

Initial investment           = Investment + Net working capital change

                                    = $3,565,000 + $281,000

                                    = $3,846,000

Present value of future cash flows calculation

Present Value = Cash flow = (1+ R)N

Year	Cash Flow	Workings for present Value	Present Value
1	$1,182,000	=$1,182,000 ÷(1.1011)1	$1,073,471.98
2	$1,182,000	=$1,182,000 ÷(1.1011)2	$974,908.71
3	$1,732,000	=$1,732,000 ÷(1.1011)3	$1,297,381.20
	Present value of future cash flows	$3,345,761.89

(Note: cash flow of Year 3 is the sum total of recovery of working capital of $281,000., Operating cash flow of $1,182,000. and salvage value of $269,000.)

NPV Calculation

NPV     = Present Value of Future cash flows – Initial investment

                = $3,345,761.89 -   $3,846,000

            =- $500,238.11

Calculation of NPV when WACC is 12.11%

Initial investment           = Investment + Net working capital change

                                    = $3,565,000 + $281,000

                                    = $3,846,000

Present value of future cash flows calculation

Present Value = Cash flow = (1+ R)N

Year	Cash Flow	Workings for present Value	Present Value
1	$1,182,000	=$1,182,000 ÷(1.1211)1	$1,054,321.65
2	$1,182,000	=$1,182,000 ÷(1.1211)2	$940,434.97
3	$1,732,000	=$1,732,000 ÷(1.1211)3	$1,229,178.15
	Present value of future cash flows	$3,223,934.77

(Note: cash flow of Year 3 is the sum total of recovery of working capital of $281,000., Operating cash flow of $1,182,000. and salvage value of $269,000.)

NPV Calculation

NPV     = Present Value of Future cash flows – Initial investment

                = $3,223,934.77 -   $3,846,000

            =- $622,065.23