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    Short term vs long term project benefits for capital and NPV

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    Scenario: Two mutually exclusive projects are being considered. First, a short-term project (a project which most of its cash inflows come in relatively soon) may have a higher ranking under NPV if the cost of capital is high (NPV Decision rules mutually exclusive projects: Accept the project with the highest positive NPV). However, a long-term project (a project which has more total cash inflows, but most are realized in later years) may be better if the cost of capital is low. Why?

    Also, would changes in the cost of capital create a change in the IRR ranking of these two projects. Is this a correct statement?

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    Solution Preview

    A short-term project whose cash flows are expected in the near future may provide a high Net Present Value if the cash flows would be high and the cost of capital (discount rate) is low. Example: Cash flow of $100 expected one year from now at a discount rate of 4% would have a higher NPV than that in which the same expected cash flow would be discounted to the present at 6% cost of capital (assuming equal initial outlay).

    A long-term project whose cash inflows are expected in later years ...

    Solution Summary

    This solution compares short- and long-term project benefits for capital and NPV.