Suppose you are evaluating two mutually exclusive projects, Thing 1 and Thing 2, with the following cash flows:

Question

a. If the cost of capital on both projects is 5%, which project, if any, would you choose? Why?

b. If the cost of capital on both projects is 8%, which project, if any, would you choose? Why?

c. If the cost of capital on both projects is 11%, which project, if any, would you choose? Why?

d. If the cost of capital on both projects is 14%, which project, if any, would you choose? Why?

e. At what discount rate would you be indifferent when choosing between Thing 1 and Thing 2?

f. On the same graph, draw the investment profiles of Thing 1 and Thing 2, indicating the following items:

Cross-over discount rate

NPV of Thing 1 if the cost of capital is 5%

NPV of Thing 2 if the cost of capital is 5%

IRR of Thing 1

IRR of Thing 2

Accepted Answer

a. At a cost of capital of [latex]5 \%, NPV _{ ext {Thing } 1}=\$ 1,677 ext { and } NPV _{ ext {Thing } 2}=[/latex] $2,045. Prefer Thing 2.

b. At a cost of capital of 8%, [latex]NPV _{ ext {Thing } 1}=\$ 907 ext { and } NPV _{ ext {Thing } 2}=[/latex] $762. Prefer Thing 1.

c. At a cost of capital of 11%, [latex]NPV _{ ext {Thing } 1}=\$ 216 ext { and } NPV _{ ext {Thing } 2}=[/latex] −$356. Prefer Thing 1.

d. At a cost of capital of 14%, [latex]NPV _{ ext {Thing } 1}=-\$ 405 ext { and } NPV _{ ext {Thing 2 }}=[/latex] −$1,331. Reject both.

e. Cross-over discount rate is 7.09%

Question 13.19: Suppose you are evaluating two mutually exclusive projects, ...