You are evaluating two possible projects for your company, both of which involve the development of a new kind of computer mouse. The projects are mutually exclusive, meaning that the company can invest in only one of them. Both projects require an initial investment of $32 million to be made in each of the next three years. Sales and profits will begin in the 4th year, and this is where the two projects differ. Version A, which is more innovative, is expected to have sales in year 4 of $24 million and cash profits of $7.8 million. Profits are expected to increase 6% annually. Version B, which is less innovative but cheaper to produce, is expected to have the same sales in year 4, but profits of $8.9 million. Profits for version B are expected to increase only 4% annually. Assume for simplicity that all cashflows occur at the end of the year. The cost of capital for both projects is 12%.

(a) Which is the better project? How much is each project worth?

(b) You have the opportunity to increase the growth rate of project B to 6%. How much would you be willing to invest (today) to get this higher growth?

(c) You are not sure that the discount rate is really 12%. What happens to the value of each project if the discount rate rises to 14% or falls to 10%? Which project is more sensitive to changes in r? Why?