W99NOONQ2.2
Which would have a bigger effect on the NPV of the project described in question 1: a one-half percentage point increase (0.005) in the 1 year spot rate (discount rate for CF’s in one year) or a one-quarter percentage point (0.0025) increase in the 2 year spot rate? WHY?
A one-half percentage point increase in the 1-year spot rate would have a larger effect because most of the project’s cash flows come in year 1: $70,000 vs. $10,000. Thus, the project’s NPV is more heavily dependent on the one-year spot rate than on the 2-year spot rate. This even outweighs compounding effect on the two-year rate.