Question

The net cash flows for project X, Y and Z are shown below. Each project has an initial cost of $100, and the company uses a 10% cost of capital (i.e., the discount rate = 10%) for each project. Which project is most sensitive to the change of the cost of capital?

End of Year	Net Cash Flow From Project
	X	Y	Z
1	$110	0	0
2	0	$121	0
3	0	0	$133.1

1. X
2. Y
3. Z
4. All the three are equally sensitive
5. Need more information to make the judgment

Answer 1

Correct answer: c. Z

Project Z is most sensitive to change in cost of capital because it has higher duration value or in other words it takes longer time to recover its initial cost.

We can check this by changing cost of capital to 9%.

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

In above calculation, we can see change in interest rate ( i.e -1%) has largest impact on NPV of Project-Z.