The WACC for two mutually exclusive projects that are being considered is 8%.Project K has an IRR of 20% while Project R's IRR is 15%.The projects have the same NPV at the 8% current WACC.However,you believe that money costs and thus your WACC will also increase.You also think that the projects will not be funded until the WACC has increased,and their cash flows will not be affected by the change in economic conditions.Under these conditions,which of the following statements is CORRECT?
A) You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market.
B) You should recommend Project R, because at the new WACC it will have the higher NPV.
C) You should recommend Project K, because at the new WACC it will have the higher NPV.
D) You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new WACC.
E) You should reject both projects because they will both have negative NPVs under the new conditions.

Question

Quizplus · Accepted Answer

Since both projects have the same NPV at the current WACC, the decision can be based on the projects' performance at the higher WACC. If we believe that the WACC will increase, then we should choose the project that will have the higher NPV at the higher WACC.

At a higher WACC, the NPV of Project R will decrease more than that of Project K because Project R's IRR is closer to the WACC. Therefore, Project K will have the higher NPV at the higher WACC, and we should recommend choosing Project K.

The WACC for Two Mutually Exclusive Projects That Are Being