Question

Hodgkiss Enterprises has gathered projected cash flows for two projects.

Year	Project I		Project J
0	–$	256,000	–$	256,000
1		114,400		88,600
2		104,200		99,600
3		88,200		101,600
4		77,200		108,600

At what interest rate would the company be indifferent between the two projects? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  

Interest rate             %

Which project is better if the required return is above this interest rate?
  

Answer 1

Indifference rate is rate at which NPV of both project is same

Project I
Discount rate	16.474%
Year	0	1	2	3	4
Cash flow stream	-256000.000	114400.000	104200.000	88200.000	77200.000
Discounting factor	1.000	1.165	1.357	1.580	1.840
Discounted cash flows project	-256000.000	98219.135	76808.252	55818.586	41946.683
NPV = Sum of discounted cash flows
NPV Project I =	16792.66
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project J
Discount rate	16.474%
Year	0	1	2	3	4
Cash flow stream	-256000.000	88600.000	99600.000	101600.000	108600.000
Discounting factor	1.000	1.165	1.357	1.580	1.840
Discounted cash flows project	-256000.000	76068.316	73417.484	64298.960	59007.898
NPV = Sum of discounted cash flows
NPV Project J =	16792.66
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

So interest rate for indifference = 16.474%

At a rate higher than this Project I has higher NPV hence it should be selected

For eg at 17%

Project I
Discount rate	17.000%
Year	0	1	2	3	4
Cash flow stream	-256000.000	114400.000	104200.000	88200.000	77200.000
Discounting factor	1.000	1.170	1.369	1.602	1.874
Discounted cash flows project	-256000.000	97777.778	76119.512	55069.483	41197.784
NPV = Sum of discounted cash flows
NPV Project I =	14164.56
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project J
Discount rate	17.000%
Year	0	1	2	3	4
Cash flow stream	-256000.000	88600.000	99600.000	101600.000	108600.000
Discounting factor	1.000	1.170	1.369	1.602	1.874
Discounted cash flows project	-256000.000	75726.496	72759.150	63436.049	57954.395
NPV = Sum of discounted cash flows
NPV Project J =	13876.09
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor