Question 1 - Project Selection Rules

You are analyzing two projects with the cash flows shown below.

Year Project 1 Project 2

0 ($6,000) ($6,000)

1 $1,000 $2,500

2 $1,000 $2,000

3 $1,500 $1,500

4 $2,000 $1,000

5 $4,000 $1,500

Please construct an NPV chart with discount rates from 1% - 25%. On your NPV chart, please identify and label the following points:

a.The IRR of project 1 (calculate the value and label the value on the chart)

b.The IRR of project 2 (calculate the value and label the value on the chart)

c.The discount rate at which the NPV of the two projects is equal - i.e., the NPV of project 1 is equal to the NPV of project 2. (calculate the value and label the value on the chart)

Questions related to the two projects (and the NPV chart):

d.Which project has the "steeper" NPV line as a function of the discount rate? Why does this project have a steeper NPV line as a function of the discount rate?

e.If you can only do one of the two projects, which project will you do if your firm's cost of capital is 6%? Why?

f.If you had no capital constraints (i.e., if you had unlimited funds), which projects would you do if your firm's cost of capital was 10%?

g.If you could only do one project, which project would you do if your firm's cost of capital was 10%? Why?

h.Which projects would you do if your firm's cost of capital was 16%? Why?