Question

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

A. A project's IRR increases as the WACC declines.
B. A project's NPV increases as the WACC declines.
C. A project's MIRR is unaffected by changes in the WACC.
D. A project's regular payback increases as the WACC declines.
E. A project's discounted payback increases as the WACC declines

Answer 1

Answer: B. A project's NPV increases as the WACC declines.

Explanation:

NPV is calculated by discounting the future cashflows at the Weighted Average Cost of Capital. This means that if the WACC is lower, the NPV will be higher because cash flow will not be discounted as much and if the WACC keeps going lower, the NPV keeps rising.

For instance, assume a company invested $10,000 and will get cash inflows of $10,000 for 2 years. What is the NPV at 10% and 15%.

NPV at 10% WACC = -10,000 + 10,000/1.1 + 10,000/1.1²

= -10,000 + 9.090.90 + 8,264.46

= $7,355.36

NPV at 15% WACC = -10,000 + 10,000/1.15 + 10,000/1.15²

= -10,000 + 8,695.65 + 7,561.44

= $6,257.09‬

Notice how NPV dropped when WACC increased.