CHOOSING MANDATORY PROJECTS ON THE BASIS OF LEAST COST Kim Inc. must install a new air conditioning
Question:
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 available, 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 7%.
HCC -$590,000 -$55,000 -$55,000 -$55,000 -$55,000 -$55,000
LCC -$100,000 -$175,000 -$175,000 -$175,000 -$175,000 -$175,000
If the WACC rose to 14% would this affect your recommendation?
- When the WACC increases to 14%, the IRR for LCC is greater than the IRR for HCC, LCC would be chosen.
- When the WACC increases to 14%, the IRR for HCC is greater than the IRR for LCC, HCC would be chosen.
- 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.
- When the WACC increases to 14%, the NPV of costs are now lower for LCC than HCC.
- When the WACC increases to 14%, the NPV of costs are now lower for HCC than LCC.
Explain your answer and the reason this result occurred.
- The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the IRR.
- The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the NPV.
- The reason is that when you discount at a higher rate you are making negative CFs higher and this lowers the NPV.
- The reason is that when you discount at a higher rate you are making negative CFs smaller and this lowers the NPV.
- The reason is that when you discount at a higher rate you are making negative CFs smaller thus improving the NPV.