Question

A tire manufacturing firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. What is the cost of capital at which the decision to take project L (or S) based on NPV will contradict the decision based on IRR method? Hint: Calculate the crossover rate and explain how the crossover rate would influence your decision to take project L or project S based on NPV vs. IRR? Show your excel work and thoroughly explain to earn your full points. (See cash flows below) (Please write down the calculation process.)

	0	1	2	3	4
Project S: CFS	-$2,050	$770	$780	$790	$795
Project L: CFL	-$4,300	$1,500	$1,518	$1,526	$1,530

Answer 1

Based on NPV rule: We see that if cost of capital is less than the crossover rate of 11.60%, we prefer L otherwise prefer S

Based on IRR rule: We see that we prefer S

Hence, NPV and IRR rule conflict when cost of capital is less than 11.60%