Question

Should luigi incorporated, which has a wacc of 11.00 percent, pursue a project that has an irr of 22.00 percent and that would involve an investment of $100,200.00 today and an expected cash flow of $124,000.00 in 1 year?

A. No, since NPV < 0
B. Yes, since NPV > 0
C. It is unclear
D. Neither yes nor no, since NPV = 0

Answer 1

Luigi Incorporated should accept the project since the IRR is higher than the WACC, and the resulting NPV is positive, indicating that the project will likely add value to the company.

Step-by-step explanation:

Luigi Incorporated should pursue the project because the internal rate of return (IRR) is significantly higher than the company's weighted average cost of capital (WACC). To determine if the project should be pursued, we compare the IRR of the project at 22.00% with the WACC of 11.00%. When the IRR exceeds the WACC, it indicates that the project is expected to generate returns greater than the cost of raising the capital, which suggests that the project will add value to the company.

To calculate the Net Present Value (NPV), we take the expected cash flow of $124,000.00 in one year and discount it back to the present value using the WACC. The NPV formula is NPV = Cash Flow / (1 + WACC)^t - Initial Investment, where 't' is the time in years. Using this formula, NPV = $124,000 / (1 + 0.11)^1 - $100,200, which simplifies to NPV = $124,000 / 1.11 - $100,200. After calculating, we find that the NPV is positive, indicating that the project should be accepted.