A firm is considering to undertake Projects X and Y, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure.
WACC: 6.00%
)million of N)
Year | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 |
CFx | -N 1,025 | N 380 | N 380 | N 380 | N 380 |
CFy | -N 2,150 | N 765 | N 765 | N 765 | N 765 |
a) Calculate the NPV of Projects X and Y and chose which one should be embarked on if they are mutually exclusive and independent.
b) Calculate and interpret the cross-over rate for both projects.
c) Calculate the Internal Rate of Return (IRR) for both projects and choose which one should be embarked on if the IRR criterion is used as a decision tool.
d) If at the firm’s cost of capital (6%), the wrong decision criterion is used, how much potential value would the firm lose?
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