Mercantile National Bank is a large integrated bank in New York. Its WACC estima
ID: 2715078 • Letter: M
Question
Mercantile National Bank is a large integrated bank in New York. Its WACC estimate is 11%. Mercantile is evaluating three investment projects: (i) opening additional retail banking branches in New York Suburbs, (ii) expanding its investment banking department in the Manhattan office, and (iii) starting making credit card loans in Pennsylvania.
A) Upon estimating the NPV of the three projects, should the required return be 11% for all? Explain.
B) Do you have a better idea (instead of applying the 11% required return uniformly)? Explain.
Explanation / Answer
A) Different discount rates should be used while evaluating projects using NPV (Net Present Value) method, but the discount rate should be more than the WACC (Weighted Average Cost of Capital)
B) Projects risk profile differ significantly, thus, the rate used for discounting while using NPV method should be adjusted with risk of respective project. Thus, the risk adjusted discount rate should be used to evaluate projects.