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Cost of Capital

My good old pal Joe the bartender called me into his place the other day with what he thought was a great riddle for me. He told me that if I get it right, he will send a case of fresh orange juice to me. He said two mutually exclusive projects are being considered. First, a short-term project might have a higher ranking under the NP criterion if the cost of capital is high. However, and here is where he lost me, a long-term project might be better if the cost of capital is low. Why is that?

As a bonus, he asked me if changes in the cost of capital would ever create a change in the IRR ranking of these two projects. What do you say?

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A short term project may have a higher ranking under the NPV method if the cost of capital is high. This is because a higher cost of capital will give a lower present value for cash flows that occur in the long term. So, if the cost of capital is high, then the ...

Solution Summary

The solution goes into a great amount of detail regarding the question being asked. Step by step explanation is provided for each part of the question which makes it very easy to follow along for anyone with just a basic understanding of the concepts. Overall, an excellent response to the question being asked.

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