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1. Safeco Company and Risco Inc are identical in size and capital structure. Though, riskiness of their assets and cash flows are somewhat different, resulting in Safeco having WACC of 10% and Risco a 12% WACC. Safeco is thinking of Project X, which has IRR of 10.5% and is of same risk as typical Safeco project. Risco is considering Project Y, which has IRR of 11.5% and is of the same risk as typical Risco project.

Now suppose that two companies merge and form new company, Safeco/Risco Inc. Moreover, new company's market risk is average of pre-merger companies' market risks, and merger has no impact on either cash flows or risks of projects X and Y. Which of the given statements is right?

a. Safeco/Risco's WACC, as result of merger, would be 10%.

b. If estimated using correct post-merger WACC, Project X would have negative NPV.

c. After merger, Safeco/Risco would have corporate WACC of 11%. Hence, it must reject Project X but accept Project Y.

d. If firm evaluates these projects and all other projects at new overall corporate WACC, it will become riskier over time.

e. After the merger, Safeco/Risco must choose Project Y but reject Project X.

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  • Category:- Accounting Basics
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