Answer:
i) Which project exhibits a higher NPV?
project 2
ii) Which project does the firm prefer?
project 1 since it has the potential to earn $400,000 (resulting in an NPV of $300,000) and if things go wrong, they will not lose their money. When you gamble with someone else's money, you are willing to take higher risks.
iii) How about debtholders?
project 2 since it guarantees that the loan will be paid back
iv) Suppose that, on 1/1/2019, the investor knows that the firm will choose a project between project 1 and 2. Would the investor choose to sign the debt contract?
This depends on what type of business Firm XYZ is. If it is a corporation, LLC or a LLP, then I doubt that the loan will be made because the firm's owners are not personally liable for the debt. If the firm is a sole proprietorship or a general partnership, then depending on the financial position of the owners, the loan can be made.
Explanation:
since the discount rate is 0:
the NPV of project 1 = [($400,000 x 0.4) + $0] - $100,000 = $160,000 - $100,000 = $60,000
the NPV of project 2 = $200,000 - $100,000 = $100,000
