Project X Has an Up-Front Cost of $1 Million, Whereas

question 38

Multiple Choice

Project X has an up-front cost of $1 million, whereas Project Y has an up-front cost of only $200,000. Both projects last five years and provide positive cash flows in Years 1-5. Project X is riskier; its risk-adjusted WACC is 12 percent. Project Y is safer; its risk-adjusted WACC is 8 percent. After discounting each of the project's cash flows at the project's risk-adjusted WACC, you find that Project X has a NPV of $20,000, and Project Y has a NPV of $15,000. The projects are mutually exclusive and cannot be repeated. The firm is not capital constrained; it can raise as much capital as it needs, provided it has profitable projects in which to invest. Given this information, which of the following statements is most correct?

• A) The firm should select Project Y because it has a higher return; ($15,000/$200,000) is greater than ($20,000/$1,000,000).
• B) The firm should select Project X because it has a higher NPV.
• C) The firm should select Project Y because it is less risky.
• D) The firm should reject both projects because their IRRs are less than the risk-adjusted WACC.
• E) Statements a and c are correct.
• Medium

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Definitions:

Net Realizable Value

The estimated selling price of inventory in the ordinary course of business minus any costs of completion, disposal, and transportation.

Allowance for Doubtful Accounts

This is a contra account that reduces accounts receivable to reflect the estimated amount of debts that may not be collected.

Accounts Receivable

Financial obligations of customers to a firm for delivered or utilized goods or services that remain unpaid.

Direct Write-off Method

An accounting method where uncollectible accounts receivable are directly written off against income at the time they are deemed uncollectible.