Question

Using Excel (if applicable),

CocaCola is considering Projects X and Y, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. What is the crossover rate and what does it tell management?

WACC:	9%
	0	1	2	3	4
CFS	-$1,000	$950	$750	$550	$350
CFL	-$1,000	$500	$600	$700	$1000

Answer 1

Crossover rate:

Crossover rate is the cost of capital,where two projects have the same NPV.

It means at this rate NPV(project 1) = NPV(project 2) or NPV(project 1) - NPV(project 2) = 0

	0	1	2	3	4
CFS (A)	($ 1,000)	$ 950	$ 750	$ 550	$ 350
CFL (B)	($ 1,000)	$ 500	$ 600	$ 700	$ 1,000
(A) - (B)	0	$ 450	$ 150	($ 150)	($ 650)

Now the NPV of difference amount sholud be 0.

Will use trial and error and find out the rate at which the NPV of difference amount will be = 0.

Let Rate = 10%, NPV = $-23.6

Let Rate = 12%, NPV = $1.12

By using interpolation we get the accurate crossover rate.

Lr + (Dl/Dl + Dh)*(Hr - Lr)

=10% + (23.6/23.6 + 1.12)*(12% -10%)

Crossover rate = 11.91 %

Crossover rate tells the management of investing company about the cost of capital at which both the mutually exclusive projects are equally good.