Consider the following two projects both costing $5,000. Assume the prevailing interest rate is 7%.
Project 1 pays $1,000 for 35 years.
Project 2 pays $950 forever.
a) What is the present value of the profits for each project?
(Hint: Use an Excel spreadsheet to solve Project 1’s PDV.)
b) Based on your answer to part a, which project would the investor prefer?
c) If the interest rises, what happens to the value of the future cash flows for each project? Which project would be affected more by a rise in interest rates? Why?
d) Use Goal Seek or Solver to find the interest rate at which an investor would be indifferent between the two projects.
(Hint: One way to ensure that the value of the two projects is identical is to create a cell in Excel that is equal to the difference in values of the two projects. Then, choose the option to set that cell equal to zero.)