Should a project be accepted if it offers an annual after-tax cash flow of $1,250,000indefinitely, costs $10 million, is riskier than the firm's average projects, and the firm uses a 12.5% WACC?

Question

Quizplus · Accepted Answer

The NPV is calculated as the present value of cash flows minus the initial investment. The cash flow is $1,250,000 indefinitely, which is a perpetuity. The present value of a perpetuity is calculated as cash flow divided by the discount rate (WACC). Here, $1,250,000 / 0.125 = $10,000,000. Since the cost is also $10 million, the NPV is zero, not negative. However, the project is riskier than average, so the WACC should be higher, leading to a negative NPV.

Should a Project Be Accepted If It Offers an Annual