Two Mutually Exclusive Projects: NPV Profiles and Discount Rate

Project L vs. Project S: Understanding the Cross at 10% Discount Rate

Prev Question Next Question

Question

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?

Answers

A. To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional piece of information.

B. Project L should be selected at any cost of capital, because it has a higher IRR.

C. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18 percent.

D. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent.

E. Project S should be selected at any cost of capital, because it has a higher IRR. C

Show Answer

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E.

Explanation

The crossover rate is the discount rate at which the NPV profiles of the two projects cross and, thus, at which the projects' NPVs are equal. As long as the discount rate is greater than the crossover rate, both the NPV and IRR methods will lead to the same conclusion.

Prev Question Next Question