hard · Principles of Finance cost-of-capital-structure
An industrial conglomerate has a β of 1.10 and a WACC of 9%. It considers a new software project (NPV of $2 million at 9%) in a sector with an average asset β of 1.60.
Given R_f = 3%, ERP = 5%, a 25% tax rate, and a tax-shielded after-tax cost of debt of 4.5% with a target D/V of 20%, what is the effect of using the corporate WACC instead of a risk-adjusted rate?
- The project's NPV will increase since the software sector offers higher growth than industrials do.
- The firm will correctly and precisely identify the project as value-neutral once cash flows are properly discounted.
- The risk-adjusted WACC will turn out to be lower than 9% due to the software sector's comparatively higher asset beta.
- The firm will accept a project that actually has a negative NPV when adjusted for its higher systematic risk.
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