8. Two of the company’s projects A and B have the same expected lives and initia

Question

8. Two of the company’s projects A and B have the same expected lives and initial cash outflows. However, one project's cash flows are larger in the early years, while the other project has larger cash flows in the later years. The two NPV profiles are given below:

Which of the following statements is most correct?

Project A has the smaller cash flows in the later years.

Project A has the larger cash flows in the later years.

We require information on the cost of capital in order to determine which project has larger early cash flows.

The NPV profile graph is inconsistent with the statement made in the problem.

None of the statements above is correct.

Explain and support your position.

Concept Check: NPV profile is the result of mapping the relationship between an investment’s NPV and various discount rates. We begin at the r of zero on the Y axis.

Helpful Hint: It may help to place some numbers on the lines beginning with known variables.

Explanation / Answer

Since NPV of Project A is greater than Project B, first statement is correct.

Project A has smaller cash flows in the later years. is CORRECT

With same initial outflow, larger the cash flow in the initial years, larger the NPV, so project A will have larger cash flow in the initial year and thus smaller cash flows in the later years (when compared to Project B)

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