Question

5) (15 pts total) Consider the cash flows and Project B Section 2 Problems sider the cash flows from two mutually exclusive projects, Project A Year Cash Flow (Proj A) -200 20 120 160 Cash Flow (Proj B) -200 140 100 40 a) (5 pts) Construct NPV profiles for each project and graph them (one graph - both profiles). b) (5 pts) Compute the crossover rate e (5 pts) Briefly explain the conflict that arises between the NPV and the IRR when the discount rate is less than crossover rate.

Answer 1

a)

	NPV A	NPV B
0%	$100.00	$80.00
2%	$85.72	$71.06
4%	$72.42	$62.63
6%	$60.01	$54.66
8%	$48.41	$47.12
10%	$37.57	$39.97
12%	$27.41	$33.19
14%	$17.88	$26.75
16%	$8.93	$20.63
18%	$0.51	$14.81
20%	($7.41)	$9.26
22%	($14.87)	$3.97

Calculate NPV for both projects using the same function in excel.

b) Crossover rate is the rate at which NPV of both projects are equal. From the table above, we can see that it is around 8%.

It can be calculated by computing IRR of the difference in the cash flows of both projects.

Crossover rate = 8.68%

A	B	A - B
-200	-200	0
20	140	120
120	100	-20
160	40	-120

c) Whenever the discount rate is less than the crossover rate, IRR and NPV gives different outcome.

In this case, IRR (A) = 18% < IRR (B) = 24%

If discount rate is 4%, NPV (A) = $72 > NPV (B) = $63

Hence, IRR suggests to pick Project B while NPV suggests to pick project A.