Question

When two mutually exclusive projects are being compared, explain why the short-term project might be ranked higher under the NPV criterion if the cost of capital is high whereas the long-term project might be deemed better if the cost of capital is low. Would changes in the cost of capital ever cause a change in the IRR ranking of two such projects? Why or why not?

Answer #1

Because of crossover rate, NPV profile is different for the two projects. Long-term projects have more sensitivity to changes in cost of capital compared to short- term project. Hence, short-term project may have higher rank under NPV criterion if cost of capital is high. But if cost of capital is low, long -term project will be ranked higher because sum of all cash flows of long term project would be more than short term project.

Yes change in cost of capital causes change in IRR ranking of such projects. One project might have greater IRR and lesser NPV when cost of capitlal is lower than the crossover rate and the other project vice versa

A firm must choose between two mutually exclusive projects, A
& B. Project A has an initial cost of $11000. Its projected net
cash flows are $900, $2000, $3000, $4000, and $5000 at the end of
years 1 through 5, respectively. Project B has an initial cost of
$15000, and its projected net cash flows are $7000, $5000, $3000,
$2000, and $1000 at the end of years 1 through 5, respectively. If
the firm’s cost of capital is 6.00%:
The...

Two projects being considered are mutually exclusive and have
the following cash flows:
Year
Project A
Project B
0
−$50,000
−$50,000
1
15,625
0
2
15,625
0
3
15,625
0
4
15,625
0
5
1,562
89,500
If the required rate of return on these projects is 13 percent,
which would be chosen and why?
a.
Project B because of higher NPV.
b.
Project B because of higher IRR.
c.
Project A because of higher NPV.
d.
Project A because of...

Two projects being considered are mutually exclusive and have
the following cash flows:
Year
Project A
Project B
0
−$50,000
−$50,000
1
15,625
0
2
15,625
0
3
15,625
0
4
15,625
0
5
1,562
89,500
If the required rate of return on these projects is 13 percent,
which would be chosen and why?
a.
Project B because of higher NPV.
b.
Project B because of higher IRR.
c.
Project A because of higher NPV.
d.
Project A because of...

11-1 How are project classifications used in the capital
budgeting process?
11-2 What are three potential flaws with the regular payback
method? Does the discounted payback method correct all three flaws?
Explain.
11-3 Why is the NPV of a relatively long-term project (one for
which a high percentage of its cash flows occurs in the distant
future) more sensitive to changes in the WACC than that of a
short-term project?
11-4 What is a mutually exclusive project? How should managers...

If mutually exclusive projects with normal cash flows are being
analyzed, the net present value (NPV) and internal rate of return
(IRR) methods agree.
Projects Y and Z are mutually exclusive projects. Their cash
flows and NPV profiles are shown as follows.
Year
Project Y
Project Z
0
–$1,500
–$1,500
1
$200
$900
2
$400
$600
3
$600
$300
4
$1,000
$200
If the weighted average cost of capital (WACC) for each project
is 14%, do the NPV and...

6. Understanding the NPV profile If projects are mutually
exclusive, only one project can be chosen. The internal rate of
return (IRR) and the net present value (NPV) methods will not
always choose the same project. If the crossover rate on the NPV
profile is below the horizontal axis, the methods will agree.
Projects Y and Z are mutually exclusive projects. Their cash flows
and NPV profiles are shown as follows. Year Project Y Project Z 0
–$1,500 –$1,500 1...

Two mutually exclusive projects each have a cost of $10,000. The
total, undiscounted cash flows from Project L are $15,000, while
the undiscounted cash flows from Project S total $13,000. Their NPV
profiles cross at a discount rate of 10 percent. Which of the
following statements best describes this situation? Please leave an
explanation. a. The NPV and IRR methods will select the
same project if the cost of capital is greater than 10 percent; for
example, 18 percent. b. The...

You are trying to determine which of two mutually exclusive
projects to undertake. Project Adam has an initial outlay of
$10,000, an NPV of $4,392.15, an IRR of 11.33%, and an EAA of
$1,158.64. Project Eve has an initial outlay of $15,000, an NPV of
$5,833.73, an IRR of 9.88%, and an EAA of $1,093.50. The cost of
capital for both projects is 9%, and the projects have different
lives. If the projects are repeatable, then:
You should do both...

You've estimated the following cash flows (in $) for two
mutually exclusive projects:
Year
Project A
Project B
0
-5,600
-8,400
1
1,325
1,325
2
2,148
2,148
3
4,193
8,192
The required return for both projects is 8%.
Part 1 : What is the IRR for project A? 3+ Decimals
Part 2 What is the IRR for project B? 3+ Decimals
Part 3 Which project seems better according to the IRR method?
Project A or Project B
Part 4 What...

A firm must choose between two mutually exclusive projects, A
& B. Project A has an initial cost of $11000. Its projected net
cash flows are $900, $2000, $3000, $4000, and $5000 at the end of
years 1 through 5, respectively. Project B has an initial cost of
$15000, and its projected net cash flows are $7000, $5000, $3000,
$2000, and $1000 at the end of years 1 through 5, respectively. If
the firm’s cost of capital is 6.00%: Project...

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