Projects S and L are both normal projects with an initial cost of $10,000,followed by a series of positive cash inflows.Project S's undiscounted net cash flows total $20,000,while L's total undiscounted flows are $30,000.At a WACC of 10%,the two projects have identical NPVs.Which project's NPV is more sensitive to changes in the WACC?
A) Project L.
B) Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital.
C) Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal.
D) The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs.
E) Project S.

Question

Quizplus · Accepted Answer

Statement a is true,while the other statements are false.Since Project L's undiscounted CFs are larger,they must occur in the more distant future,and since distant cash flows are impacted more by changes in the discount rate,L's NPV profile must be steeper.One can also see this in an NPV profile graph like the one in Question 50.The higher Y-axis intercept indicates more undiscounted CFs,and for the profiles to cross,the one with the higher intercept must be steeper.

Projects S and L Are Both Normal Projects with an Initial