11. Problem 11.14 (Choosing Mandatory Projects on the Basis of Least Cost) Kim Inc. must install a new air-conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are avallabie, HCC and LCC (for high and low capital costs, respectively). HCC has a high capital cost but relatively low operating costs. while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown here. Kim's WACC is 6%. a. Which unit would you recommend? 1. Since all of the cash flows are negative, the NPV's cannot be calculated and an altemative method must be employed. If. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV. 111. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since HCC s NPY of costs is lower than LCC's, HCC would be chosen. TV. Since all of the cash fows are negative, the 1RR's will be negative and we do not accept any project that has a negative IRR. V. Since we are examining costs, the unit chosen would be the one that had the lower NPY of costs. Since LCC's NPY of costs is lower than HCC's. LCC would be chosen. b. If Kim's controller wanted to know the 12rs of the two projects, what would you tell him? 1. The IRR cannot be calculated because the cash flows are in the form of an annuity. 11. The IRR of each project will be positive at a lower WACC, 11. There are multiple 1RR's for each project. TV. The IRR of each project is negative and therefore not useful for decision-making. V. The IRR cannot be calculated because the cash flows are all one sign. A change of sign would be needed in arder to calculate the IRR. c. If the WACC rose to 12% would this affect your recommendation? 1. When the WACC increases to 12%, the NPV of costs are now lower for LCC than HCC. It. When the WACC increases to 12%, the NPV of costs are now lower for HCC than LCC. III. When the WACC increases to 12%, the IRR for LCC is greater than the IRR for HCC, LCC would be chosen. IV. When the WACC increases to 12%, the IRR for HCC is greater than the IRR for LCC, HCC would be chosen. V. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negotive NPV. Why do you think this result occurred? 1. The reason is that when you diecount at a higher rate you are making negative CFs smalier and this lowers the NPV. II. The reason is that when you discount at a higher rate you are making negative CFs smaller thus improving the NPY. 111. The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the IRR. N. The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the NPV. V. The reason is that when you discount at a higher rate you are making negative CFs higher and this lowers the NPV