Question

Unitron Corp. Is considering project Z, which costs $50 million and offers an annual after-tax cash flow of $7.5 million in perpetuity. The project is in an industry that has greater market risk than Unitron's typical projects. Unitron's company weighted-average cost of capital, based on its typical projects, is 15%. Should Unitron Corp. Accept project Z?

Answer 1

Answer: No, because the NPV of the project is negative.

Explanation:

First calculate the present value of this project's cashflows.

As it is in perpetuity, the present value is;

= Annual Cashflow/ Discount rate

= 7,500,000/0.15

= $50,000,000

NPV = Present Value of Cashflow - Investment

= 50,000,000 - 50,000,000

= $0

We discounted using the company's WACC but this project is said to be in an industry that has greater risk than Unitron's other projects.

This means that the relevant rate will be higher than 15% and when NPV is computed with anything higher than 15% for this project, the NPV will be negative because 15% is where it is at $0.

This project should not be accepted because it will have a negative NPV.