Question

Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S.

Answer 1

Answer:

The Statement is True.

Explanation:

From what was given, and keeping

Other things held constant, if the cost of capital decrease, there will be an increase in the net present value of Project L because Project L has longer life and with large cash flow at late in life. It will be discounted at lower discount rate which results in more present value of cash flow while Project S cash flows are occurring in early years will be discounted at higher discount rate and advantage of low cost discounting would not be availed, this is the reason NPV of project L will increase in comparison to that of Project S.

Answer 2

The following information should be considered:

• The given statement is true as the other things being constant in the case when the cost of capital reduced due to this the net present value of Project L should be increased.
• As Project L contains the long life and having large cash flow should be discontinued at less discount rate that resulted in more present value of the cash flow.
• On the other hand, the Project S cash flows arise in early years so it should be discounted at the high discount rate also the advantage of less cost discounted should not be availed.
• Due to this, The NPV of project L should increased as compared to Project S.

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