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Question

CHOOSING MANDATORY PROJECTS ON THE BASIS OF LEAST COST

Kim Inc. must install a new air

conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs, respectively). HCC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown here. Kim's WACC is 7%.

HCC -$590,000 -$55,000 -$55,000 -$55,000 -$55,000 -$55,000

LCC -$100,000 -$175,000 -$175,000 -$175,000 -$175,000 -$175,000


If the WACC rose to 14% would this affect your recommendation? 

  1. When the WACC increases to 14%, the IRR for LCC is greater than the IRR for HCC, LCC would be chosen.
  2. When the WACC increases to 14%, the IRR for HCC is greater than the IRR for LCC, HCC would be chosen.
  3. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV.
  4. When the WACC increases to 14%, the NPV of costs are now lower for LCC than HCC.
  5. When the WACC increases to 14%, the NPV of costs are now lower for HCC than LCC.




Explain your answer and the reason this result occurred. 

Top Answer

At present value of 7% we would have chosen HCC project but at WACC of 15%, we would choose LCC project because its... View the full answer

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HCC
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PV factor at 7% PV factor at 14% Present value @7% Present Value @14% Present value @7% Present Value @14%
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