Question

Crenshaw Enterprises has gathered projected cash flows for two projects.

Year Project I Project J
0 −$ 266,000 −$ 266,000
1 113,400 94,600
2 106,200 100,600
3 90,200 102,600
4 79,200 109,600
At what interest rate would the company be indifferent between the two projects? Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. Which project is better if the required return is above this interest rate?

Answer 1

The interest rate at which Crenshaw Enterprises would be indifferent between the two projects can be found by calculating the IRR for both and setting them equal to each other. Once this rate is determined, the project with the higher later cash flows would be generally better if the required return is above this indifference rate.

Step-by-step explanation:

To find the interest rate at which Crenshaw Enterprises would be indifferent between Project I and Project J, we need to calculate the Internal Rate of Return (IRR) for both projects. The IRR is the rate at which the Net Present Value (NPV) of all cash flows (both incoming and outgoing) from a project equals zero. Since both projects have the same initial investment, we are looking for a rate where the present value of their respective cash inflows are equal.

By setting the NPVs of both projects equal to each other at various rates, we can find the point of indifference. This requires either using a financial calculator or software capable of IRR computation because there isn't a straightforward algebraic solution for IRR when dealing with multiple cash flows over time.

Once the interest rate is found, we can determine which project is better by comparing this rate to the required return. If the required return is above the rate of indifference, the project with higher later cash flows would generally be better, as it would appreciate more with a higher compounding rate, assuming no other risks or factors.