Assume the following: (1)A firm is considering two projects,one with a 5-year life and the other with a 10-year life;(2)the cash flows of the two projects are equally risky by all definitions of the word "risky";(3)the company uses 40 percent debt and 60 percent equity to finance the projects;(4)the debt used to finance any given project has a maturity equal to the life of the project;and (5)the term structure of interest rates has a sharp upward slope.This would suggest,other things held constant,that a lower discount rate should be used to find the NPV for the 5-year project than for the 10-year project.

Question

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Given the sharp upward slope in the term structure of interest rates, longer-term debt (for the 10-year project) would have a higher interest rate compared to shorter-term debt (for the 5-year project). However, the discount rate for a project is influenced by the cost of capital, which includes the cost of debt. Since the cost of debt for the 10-year project would be higher due to higher interest rates associated with longer maturities, the discount rate applied to the 10-year project should be higher, not lower, compared to the 5-year project.

Assume the Following: (1)A Firm Is Considering Two Projects,one with a 5-Year