You are given with the following information of two projects planned by your company. Two projects are of the same initial costs with $2 millions. Project Year 1 Year 2 Year 3 Year 4 Year 5
A -180 750 -170 1000 1800
B -210 94 1625
Answer the following questions.
a) Suppose the weighted average cost of capital is 10%. What are the Net Present Values for these two projects? Which project is better? What are the limitations for this criterion?
b) Suppose the financial manager discovered that if we postponed the project B to two years later, the cost of capital could be 8% due to possible low future interest rates. However, the deferment may cost the firm additional $0.5 million to restart the facilities and the initial cost must be spent now, instead of two years later. Will you recommend waiting for additional 2 years to start?
c) Let the corporate income tax rate be 30%, the cost of debts be 6%, the cost of equity be 25% and there is no preferred stock issued by the firm. What is the debt-to-equity ratio for your company if the cost of capital is given as in a)?
d) Find the IRR (Internal Rate of Return) for project A and project B. Which project will you choose? What are the limitations for this criterion?