Question

Decision rule Conflict.

Bob Sponge has been retained as a management consultant by Square Pants, Inc., a local specialty retailer to analyze two proposed capital investment projects, projects X and Y. Project X is a sophisticated working capital and inventory control system based upon a powerful personal computer, called a system server and PC software specifically designed for inventory processing and control in the retailing business. Project Y is a similarly sophisticated working capital and inventory control system based upon a powerful personal computer and general- purpose PC software. Each project has a cost of $10,000, and the cost of capital for both projects is 12%. The projects= expected net cash flows are as follows:

Expected Net Cash Flow

Year	Project X	Project Y
0	($10,000)	($10,000)
1	6,500	3,500
2	3,000	3,500
3	3,000	3,500
4	1,000	3,500

How might a change in the cost of capital produce a conflict between the NPV and IRR rankings of these two projects? At what values of k would this conflict exist? (Hint: Plot the NPV profiles for each project to find the crossover discount rate k.)

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

05 46 VEO A dx х ENG 162 16 01 2020 P/26 702 PROJECT A PROJECT B INCREMENTAL CF NPV PROFILE 703 YEAR CF CF A-B 704 -10000 -10000 3000 705 6500 3500 PROJECT B PROJECTA - 706 $5,000.00 3000 3500 -500 3000 3500 707 -500 708 -2500 $4,000.00 1000 3500 709 710 18.03% IRR = 14.96% 6.22% $3,000.00 [=IRR(J704:J708)] [=IRR(K704:K708)] [=IRR(L704:L708)] [CROSSOVER RATE] 711 712 $2,000.00 713 NPV PROFILE 714 PROJECT A PROJECT B RATE $1,000.00 $ 3,500.00 715 $4,000.00 0% $ 2,410.83 716 5% $2,325.78 $00 $ 1,707.06 $ 1,325.39 $ 966.01 $ 464.91 $ 4.71 $-281.64 717 8% $1,592.44 20% 0% 10% 15% 25% $1,094,53 718 10% $-1,000.00 $ 630.72 $-7.58 $-584.78 12% 719 720 15% $-2,000.00 721 18% RATE 722 $-939.43 20% 723 724 ANSWER 1 AT 12% COST OF CAPITAL, PROJECT A IS BETTER 725 BELOW CROSSOVER RATE (6.22%), THERE IS A CONFLICT BETWEEN NPV AND IRR SO IF COST OF CAPITAL IS BELOW 6.22%, THERE IS ALWAYS CONFLICT BETWEEN NPV AND IRR 726 727 728 ANSWER 2 CONFLICT EXISTS BETWEEN RATES : 0% TO 6.22% 729 ANSWER 3 CROSSOVER RATE IS 6.22% 730 REPLACEMENT | BOND OPTION TO WAIT| STE . O IRRripvbela | RATIO PI PBP ARR | invest, EAA | HPR GMAM EAC MACRS | NPV | RELEVANT BETA LEVERED MI-np-ir REPLACEMENT S