Consider the following case study and answer the questions.
- Coca-cola is evaluating a potential investment in a new manufacturing facility located in Indonesia. The initial capital investment in this facility is $200 million with an expected useful life of 20 years.
- The manufacturing facility is to be depreciated to a book value of $0 over the 20 years and it is expected that it can be sold for $50 million at the end of the project.
- Coca-cola has already commissioned a consulting firm in order to perform a technical due diligence of the manufacturing facility. The services fee paid amount to $1 million.
- The incremental revenue that Coca-cola is planning to generate with the new facility will be $35 million per year for the 20 years (starting at the end of year 1).
- The annual variable cost for the manufacturing facility will be 20% of the incremental revenues for every year.
- The project requires $5 million of additional working capital immediately but it will not require any other working capital investments during its life. The working capital will be recovered in the last year of the project.
- The corporate tax rate is 30% and Coca-cola has a weighted average cost of capital of 10%.
- Coca-cola is planning to finance this project using a higher proportion of debt than the one used to finance the company as a whole.
You are told in the question that Coca-cola will be financing the project using a higher proportion of debt than the one used to finance the company as a whole. What risk is Coca-cola incurring by using the company's WACC as a discount rate? What would happen to the WACC and NPV of the project in the case Coca-cola would be using the appropriate discount rate?
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