Midwest Water Works estimates that its WACC is 10.5%. The company is considering
ID: 2664784 • Letter: M
Question
Midwest Water Works estimates that its WACC is 10.5%. The company is considering the following capital budgeting projects:
Project Size Rate of Return
A $1 million 12.0%
B 2 11.5
C 2 11.2
D 2 11.0
E 1 10.7
F 1 10.3
G 1 10.2
Assume that each of these projects is just as risky as the firm's existing assets and that the firm may accept all the projects or only some of them. Which set of projects should be accepted ? Explain.
Explanation / Answer
Project
Rate of Return
WACC
Accept / Reject
A
12.00%
10.50%
Accept
B
11.50%
10.50%
Accept
C
11.20%
10.50%
Accept
D
11.00%
10.50%
Accept
E
10.70%
10.50%
Accept
F
10.30%
10.50%
Reject
G
10.20%
10.50%
Reject
The projects which have a higher return than the WACC will be accepted. This is as per the Accept rule based on the IRR method.
Hence, Project A, B, C, D, E will be accepted being given the higher rate of return than the WACC which is 10.5 %
The project whose return is more than that of the WACC should be accepted. Based on this project F & G rejected.
IRR > WACC Accepted
IRR < WACC Rejected
Project
Rate of Return
WACC
Accept / Reject
A
12.00%
10.50%
Accept
B
11.50%
10.50%
Accept
C
11.20%
10.50%
Accept
D
11.00%
10.50%
Accept
E
10.70%
10.50%
Accept
F
10.30%
10.50%
Reject
G
10.20%
10.50%
Reject