Economy

Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high. The WACC for two mutually exclusive projects that are being considered is 12%. Project S has an IRR of 20% while Project L’s IRR is 15%. The projects have the same NPV at the 12% current WACC. However, you believe that the economy will soon fall into a mild recession, and money costs and thus your WACC will soon decline. You also think that the projects will not be funded until the WACC has decreased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?

Answer

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You should reject both projects because they will both have negative NPVs under the new conditions.

You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market.

You should recommend Project L, because at the new WACC it will have the higher NPV.

You should recommend Project S, because at the new WACC it will have the higher NPV.

You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.