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Chrome FileEdit View History Bookmarks People Window Help ng.cengage.com/static/nb/ui/index.html?nbld-325046&nbNodeld-10685; 7051&deploymentid;=4738028 MindTap Assignment 11 - The Basics of Capital Budgeting - - MindTap -Cengage Learning & Due Today at 11 59 PM CDT 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 exdusive projects. Their cash flows and NPV profiles are shown as follows. NPV IDollars 800 Year Project Y Project Z 0 $1,500 -$1,500 $200 $900 $400 $600 $600 $30 4 $1,000 $200 600 Project Y Project z 200 If the weighted average cost of capital (WACC) for each project is 14%, do the NPV and IRR methods agree or conflict? -200 O The methods conflict O The methods agree. 0 2 4 68 10 12 14 16 18 20 COST OF CAPITAL Percent 8 LrExplanation / Answer
Firstly we need to calculate the cross over rate of this. The crossover rate is the discount rate that makes the NPVs of both the projects equal, i.e it makes npv difference between the two projects cash flow 0. to determine the cross over rate , subtract the cash flows of projects z from those of project y .
0 1 2 3 4
project y - project z 0 $ -700 $-200 $300 $800
using financial calculator we enter CF0 =0 CF1=-700 CF2=-200 CF3=300 CF4=800 CPT IRR = 8.3445%
other wise IRR is the rate where npv is 0 using that part
0 = CF0+CF1/(1+IRR)^1 +CF2/(1+IRR)^2 + CF3(1+IRR)^3 +CF4(1+IRR)^4
Computing NPV & IRR of both projects individually :-
NPV = CF0+ CF1/(1+k)^1 +CF2/(1+k)^2 + CF3/(1+k)^3 + CF4/(1+k)^4
where cf is cash flow of that period and k is the cost of capital
Project Y = $-1500 + 200(1+.014)^1 + 400(1+0.14)^2 + 600(1+0.14)^3 + 1000(1+0.14)^4 = $-19.7122
Project Z = $-1500 + 900(1+0.14)^1 +600(1+0.14)^2 + 300(1+0.14)^3 + 200(1+0.14)^4 =$72.0617
by NPV rule we select Project Z whose NPV is +ve
IRR method
where npv is zero
0 = CF0+CF1/(1+IRR)^1 +CF2/(1+IRR)^2 + CF3(1+IRR)^3 +CF4(1+IRR)^4
Project Y 0 = $-1500 + 200(1+IRR)^1 + 400(1+IRR)^2 + 600(1+IRR)^3 + 1000(1+IRR)^4 =13.4912 %
Project Z 0 = $-1500 + 900(1+IRR)^1 +600(1+IRR)^2 + 300(1+IRR)^3 + 200(1+IRR)^4 = 17.0702%
in method project Z is selected because IRR> reqiured rate of return/cost of capital
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