Question

12. Assume you are trying to compare Project Alpha to Project Beta. Both projects have the same appropriate discount rate. Project Alpha generates infinite after tax cash flows which do not grow; the first cash flow is $80M one year from now (T=1) and will cost $600M today (T=0). Project Beta generates infinite after tax cash flows which do not grow; the first cash flow is $40M one year from now (T=1) and will cost $300M today (T=0). Which statement about the crossover rate for Project Alpha and Project Beta is most accurate?

1. If the appropriate discount rate for both projects was below the crossover rate of 13.3%, Project Alpha would have a better NPV than Project Beta

2. If the appropriate discount rate for both projects was below the crossover rate of 4.4%, Project Alpha would have a better NPV than Project Beta

3. If the appropriate discount rate for both projects was above the crossover rate of 4.4%, Project Alpha would have a better NPV than Project Beta

4. If the appropriate discount rate for both projects was above the crossover rate of 13.3%, Project Alpha would have a better NPV than Project Beta

5. If the appropriate discount rate for both projects was below the crossover rate of 20.0%, Project Alpha would have a better NPV than Project Beta

Answer 1

	project Beta	Project Alpha	incremental cash flow
cash outflow	-300	-600	-300
cash inflow	40	80	40
cross over rate = cash inflow/cash outflow	40/300	13.33%
NPV of project Alpha
cash outflow		-600
cash inflow		80
present value of cash inflow = cash inflow/cross over rate	80/13.33%	600.15004
NPV of project Alpha	600.15-600	0.15
NPV of project Beta
cash outflow		-300
cash inflow		40
present value of cash inflow = cash inflow/cross over rate	40/13.33%	300.07502
NPV of project Alpha	300.075-300	0.075
If the appropriate discount rate for both projects was below the crossover rate of 13.3%, Project Alpha would have a better NPV than Project Beta