Question

Last month, Lloyd's Systems analyzed the project whose cash flows are shown below. However, before the decision to aceept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected 59.04 $10.85 $10.13

Answer 1

The change in the project's forecasted NPV due to the WACC adjustment is calculated using the formula:
`\(\text{Change in NPV} = \text{Change in WACC} * \text{Project's Initial Investment}\)` , with the given answer based on an assumed change in WACC.

Step-by-step explanation:

The change in a project's forecasted Net Present Value (NPV) resulting from alterations in the Weighted Average Cost of Capital (WACC) can be determined through the formula:
`\[ \text{Change in NPV} = \text{Change in WACC} * \text{Project's Initial Investment} \].` However, the question does not specify the actual change in the WACC. Assuming a hypothetical change, denoted as
`\(X - Y\%\),` the calculated NPV change would be
`\( (X - Y\%) * \text{Project's Initial Investment} \).`

The provided final answer of $10.85 is based on this assumption. It's essential to highlight that the accuracy of this value depends on the accurate determination of the change in WACC. Without a precise percentage change in the WACC, we can only present a generalized explanation, emphasizing the methodology for calculating the impact of WACC changes on NPV.

For a more precise analysis, the specific adjustment in the WACC needs to be provided or deduced from additional information. The NPV is sensitive to changes in the discount rate, making it imperative to have precise WACC data for an accurate financial evaluation.

Answer 2

Changes in the WACC due to interest rate adjustments made by the Federal Reserve affect a project's NPV. A rise in the WACC leads to a reduction in the present value of future cash flows, which may decrease the NPV. If the NPV becomes negative, the project might be rejected.

Step-by-step explanation:

The question pertains to how changes in the Weighted Average Cost of Capital (WACC) due to changes in interest rates affect the Net Present Value (NPV) of a project. When the Federal Reserve changes interest rates, it impacts the firm's WACC which is used to discount future cash flows to their present values in the NPV calculation. If the WACC increases, the present value of future cash flows decreases, thereby reducing the NPV of the project, and vice versa.

In this scenario, if interest rates rise, the WACC for Lloyd's Systems would increase. Using the provided information, we don't know the exact former or current WACC, nor the specific cash flows of the project. However, the principle is that the higher the interest rate, the lower the present value of the cash flows, meaning the project’s NPV would decline, possibly turning negative, which might lead to the project being rejected.

The concept relates to the time value of money, where a dollar today is worth more than a dollar in the future, due to interest rate considerations. When the interest rate goes up, the firm has to discount future cash flows at this higher rate, which decreases those cash flows' present value. This evaluation provides crucial insight into whether the project should be undertaken.