Two mutually exclusive projects produce the same positive NPV at a discount rate

Question

Two mutually exclusive projects produce the same positive NPV at a discount rate of 11.34 percent. Both projects have 4-year lives. Project A has larger cash flows than Project B in the first 2 years. Given this information, you know that

A) it makes no difference which project you accept as long as the discount rate does not exceed 11.34 percent.

B) Project A should always be preferred.

C) one project will be preferred at rates less than 11.34 percent and the other will be preferred at higher rates.

D) Project B must require a smaller investment than Project A at Time 0.

E) Project B should only be accepted if the discount rate is 11.34 percent.

Explanation / Answer

Two mutually exclusive projects produce the same positive NPV at a discount rate of 11.34 percent. Both projects have 4-year lives. Project A has larger cash flows than Project B in the first 2 years. Given this information, you know that Project B must require a smaller investment than Project A at Time 0.

Therefore correct answer is option D) Project B must require a smaller investment than Project A at Time 0.

Because if the higher cash flows occur in the later years, its present value will reduce more severely after discounting and if the higher cash flows occur in the initial years, its present value will be more after discounting with same discount rate. We know that both projects produce the same positive NPV at a discount rate of 11.34 percent and both projects have 4-year lives therefore Project B requires a smaller investment than Project A at Time 0 to give same positive NPV.

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