Question $3.$ Discounted Cash Flows $+$ CAPM $(1\mathrm{.}5$p$)$

Leon Joint Stock company is considering to invest in a new equipment. If Leon

continues to use its current machine, the net cash inflow is $$150,000$ per year. The net

cash flow is expected to increase at $8\%$ per year. The lifespan of the current machine is

about $25$ years.

If Leon purchases a new equipment, the net cash inflow is $$180,000$ per year. The cash

inflow will increase by $7\%$ per year. At the moment, if Leon sells its current machine,

then purchases the new equipment, the net cash outflow would be $$20,000.$ The current

weighted average cost of capital $($WACC$)$ is $5\%.$ The cash inflows will occur from year

The cash outflow will arise in year $0.$

a$)$ Use $5\%$ as the discount rate to calculate the NPV of the two projects: the current

machine and the new equipment. Should Leon purchase the new equipment? $(0\mathrm{.}5p$

b$)$ What are the consequences of using WACC as a discount rate for all projects without

considering their risk levels? Should Leon use his current WACC $(5\%)$ to calculate the

NPV of his new equipment? Why? What are the conditions for Leon to use its current

WACC as a discount rate for the new equipment? $(0\mathrm{.}5p)$

c$)$ Re$-$answer $($a$)$ if using a $6\%$ discount rate for the new equipment. $(0\mathrm{.}5p)$