how to calculate NPV using WACC | Solution Library

Question

Acme, Inc.

Balance Sheets as of 12/31/09 and 12/31/10

($ in thousands)

2007 2008 2007 2008

Cash $ 2650 2810 accounts payable $ 1350 $ 1000

Accounts rec. 980 840 long-term debt 3300 3300

Inventory 1560 1990 common stock 3200 3500

Total $ 5190 5640 retained earnings 940 1200

Net fixed assets 3600 3360

Total asset $ 8790 $ 9000 total liabilities & equity $ 8790 $ 9000

Notes to Financial Statements: The rate and amount of the Company’s total long-term, fixed rate debt outstanding for the Company in 2009 and 2010 remained unchanged. The 12/31/10 market rate on debt for companies with a similar risk profile and maturity as Acme’s was 12%. The market value of Acme’s long-term debt on 12/31/10 was $3 million. Acme’s market capitalization on 12/31/10 was $6 million. As of 12/31/10, the risk free rate was 3%, the expected market rate of return was 11%, and Acme’s beta was 1.50. Due to a large net-operating-loss-cany-forward and substantial tax credits, Acme paid no taxes in 2009 and 2010, and it is NOT expected that the Company will be paying any taxes in the next 5 years.

Based on the financial statements above, if Acme was considering investing in a project that is expected to yield after-tax cash flow of $1,000 million, $2,500 million, and $3,000 million, in years 1 through 3 respectively, with no further income or salvage value beyond year 3, please determine the NPV using the WACC that you calculated above, and an investment in year zero of $4,000 million. Should Acme invest in this project?

a. No because the NPV is -$1.235 million.

b. No because the NPV is -$0,826 million.

c. No because the NPV is $0,537 million.

d. Yes because the NPV is $0,826 million.

e. Yes because the NPV is $1.235 million.