Question

Explain why NPV profiles of different projects can cross over? What kind of projects tend to have steeper and flatter NPV profile? What is the implication of the slope of NPV profile?

Answer 1

NPV profiles of different projects can cross over because of the following two reasons –

• Timing differences: If most of the cash flows from one project come in early stage and another project it come in later stage; the NPV profiles of both projects may cross.
• Project size: If the amount invested in one project is larger than the other then the payback period will be longer for first project and the NPV profiles of both projects may cross.

If more of Project’s cash flows occur in the later years, it will more severely penalized by the discount rates and it will have steeper slope in the NPV profile and lower Internal rate of return (IRR)

If more of Project’s cash flows occur in early stage, it will have flatter NPV profile and higher IRR.

The slope of the NPV profile depends on the timing of the cash flows of project; for long term projects NPV profiles are steeper in comparison of short term projects.