Careco Company and Audaco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Careco having a WACC of 10% and Audaco a WACC of 12%. Careco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Careco project. Audaco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Audaco project.
Now assume that the two companies merge and form a new company, Careco/Audaco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y. Which ONE of the following statements is CORRECT?
A. If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
B. After the merger, Careco/Audaco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.
C. Careco/Audaco's WACC, as a result of the merger, would be 10%.
D. After the merger, Careco/Audaco should select Project Y but reject Project X. If the firm does this, its corporate WACC will fall to 10.5%.
E. If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will probably become riskier over time.