Question

1. You are analyzing the following two mutually exclusive projects and have developed the following information. Please calculate the IRRs for the two projects and the crossover rate. Which project should you accept if the cost of capital is 5%, and which project should you accept if the cost of capital is 10%?

Year Project A Cash Flow Project B Cash Flow
0 -$84,500 -$76,900

1 $29,000 $25,000

2 $40,000 $35,000

3 $27,000 $26,000

IRR A: ___________

IRR B: ___________

Crossover Rate: ____________

If WACC=5%, accept _______

If WACC=10%, accept _______

Answer 1

Answer:

IRR A = 6.73%

IRR B = 5.77%

Crossover Rate = 17.90%

If WACC = 5%, Accept Project A. At WACC = 5%, NPV of project A is higher.

If WACC = 10%, accept NONE. At WACC = 10%, both the projects have negative NPV.

Workings:

Cross over rate:

1. We can calculate crossover rate by calculating the differential cash flows and its IRR as done above.

2. By plotting graph of NPV profile as below and finding a the WACC at which NPV of Project A = NPV of Project B

NPV Profile and graph:

As we observe from graph the cross over rate is 17.9%