Careco Company and Audaco Inc Are Identical in Size and Capital

question 22

Multiple Choice

Careco Company and Audaco Inc are identical in size and capital structure.However, the riskiness of their assets and cash flows are somewhat different, resulting in Careco having a WACC of 10% and Audaco a WACC of 12%.Careco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Careco project.Audaco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Audaco project.
Now assume that the two companies merge and form a new company, Careco/Audaco Inc.Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y.Which of the following statements is CORRECT?

• A) If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
• B) After the merger, Careco/Audaco would have a corporate WACC of 11%.Therefore, it should reject Project X but accept Project Y.
• C) Careco/Audaco's WACC, as a result of the merger, would be 10%.
• D) After the merger, Careco/Audaco should select Project Y but reject Project X.If the firm does this, its corporate WACC will fall to 10.5%.
• E) If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will probably become riskier over time.