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,what will happen to projects S and L?
A)Other things held constant, this change will cause L to become preferred to S.
B)Other things held constant, this change will cause S to become preferred to L.
C)Other things held constant, this change will cause L and S to have the same NPV.
D)Other things held constant, money and interest rates will not affect the financial outcomes of S and L.

Question

Quizplus · Accepted Answer

Since interest rates and money costs are declining, the value of future cash flows is increasing. Hence, the cash flows from Project L, which occur later in its life, will be worth more now than before, causing its NPV to increase more than Project S. As a result, Project L will become preferred to Project S.

Project S Has a Pattern of High Cash Flows in Its