Question
Project X has an up-front cost of $1 million, whereas Project Y has an up-front cost of only $200,000. Both projects last five years and
Project X has an up-front cost of $1 million, whereas Project Y has an up-front cost of only $200,000. Both projects last five years and provide positive cash flows in Years 1-5. Project X is riskier; its risk-adjusted WACC is 12 percent. Project Y is safer; its risk-adjusted WACC is 8 percent. After discounting each of the projects cash flows at the projects risk-adjusted WACC, you find that Project X has a NPV of $20,000, and Project Y has a NPV of $15,000. The projects are mutually exclusive and cannot be repeated. Given this information, which of the following statements is most correct?
a. The firm should select Project Y because it has a higher return; ($15,000/$200,000) is greater than ($20,000/$1,000,000).
b. The firm should select Project Y because it is less risky.
c. The firm should reject both projects because their IRRs are less than the risk-adjusted WACC.
d. Statements a and c are correct.
e. The firm should select Project X because it has a higher NPV.
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