Question

Your firm is considering overhauling its production plant. The engineering team has come up with two proposals, one for a minor overhaul and one for a major overhaul. The two options are mutually exclusive and have the following cash flows. What is the crossover rate? If the cost of capital for both of these projects is 15%, what should your firm do?

Year Cash Flow ($ millions)

Proposal	0	1	2	3
Minor Overhaul	-10	6	6	6
Major Overhaul	-50	25	25	25

Answer 1

E21 fx А B с D E F 1 2 Years Difference in Cash flows Minor Overhaul Major Overhaul -10 3 0 -50 -401 4 1 6 25 19 5 2 6 25 19 6 3 6 25 19 20.04% 7 Crossover Rate 8 9 10 Crossover rate is calculated By taking the difference of cash flows and then finding the Internal rate of return of these cash flows. 11 12 13 Crossover rate is the rate at which the net present value of both project will intersect. 14 15 16 Internal rate of return is calculated by formulae =IRR( Values) where values are cash flows of all the years. 17 18

E21 for A B с D E 1 Years Minor Overhaul N 3 0 -10 Major Overhaul -50 25 4 1 6 Difference in Cash flows =D3-C3 =D4-C4 =D5-C5 =D6-C6 =IRR(E3:E6) 5 2 6 25 6 3 6 25 7 Crossover Rate 8 9 10 Crossover rate is calculated By taking the difference of cash flows and then finding the Internal rate of return of these cash flows. 11 12 13 14 Crossover rate is the rate at which the net present value of both project will intersect. 15 16 Internal rate of return is calculated by formulae SIRR( Values) where values are cash flows of all 17 the years. 18