Use the graph below to answer the following two statements. (2) Project _________ has the higher IRR. At a discount rate of rate 10%, project _________ should be chosen.
Use the graph below to answer the following two statements. (2) Project _________ has the higher IRR. At a discount rate of rate 10%, project _________ should be chosen.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Use the graph below to answer the following two statements. (2)
Project _________ has the higher
At a discount rate of rate 10%, project _________ should be chosen.
Transcribed Image Text:### Net Present Value (NPV) vs Cost of Capital Analysis
The graph above illustrates the relationship between Net Present Value (NPV) and Cost of Capital for two different projects, labeled as Project A and Project B.
#### Graph Description
- **Axes**:
- The **horizontal axis** (X-axis) represents the **Cost of Capital**, ranging from 0% to 45%.
- The **vertical axis** (Y-axis) represents the **Net Present Value (NPV)** in dollars, ranging from -$600.00 to $1,400.00.
- **Curves**:
- **Project A** is represented by the **dashed line**.
- **Project B** is represented by the **solid line**.
#### Analysis
1. **Initial NPV (at 0% Cost of Capital)**:
- Project A: Approximately $1,200.00
- Project B: Approximately $900.00
2. **Intersection Point**:
- The curves for Project A and Project B intersect around the Cost of Capital of **25%**.
- At the 25% Cost of Capital, both projects have an NPV of roughly $200.00.
3. **Trend**:
- Both curves show a decreasing trend as the Cost of Capital increases.
- Project A has a steeper decline compared to Project B, indicating it is more sensitive to changes in the Cost of Capital.
4. **Negative NPV**:
- Both projects reach a negative NPV before the Cost of Capital hits 40%.
- Project B maintains a positive NPV at a higher Cost of Capital compared to Project A.
#### Conclusion
When evaluating Project A and Project B:
- For lower Cost of Capital (0% to 25%), Project A has a higher NPV than Project B, making it a more attractive investment.
- As the Cost of Capital increases beyond 25%, Project B becomes a better investment due to its relatively slower decline in NPV.
- Investment decisions should consider the sensitivity of NPV to changes in the Cost of Capital for each project.
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