Question
In: Finance
1. Provide two conditions under which a set of projects might be characterized as mutually exclusive....
1. Provide two conditions under which a set of projects might be characterized as mutually exclusive.
2. Under what circumstances might the IRR and NPV approaches produce conflicting results?
Solutions
Expert Solution
1. Provide two conditions under which a set of projects might be characterized as mutually exclusive.
A set of projects are considered mutually exclusive when if one project is taken the other project cannot be taken.
- Resource constraint: There is no capital to invest in both the projects
- The two projects are of similar type. Taking one project makes the other project redundant.
2. IRR and NPV approaches produce conflicting results when the projects are mutually exclusive and the size of investments differ significantly in two projects.
Example: Project 1: Initial investment is $10,000. One year cash flow is $20,000
IRR = 100%
NPV at 10% discount rate = -10,000 + 20,000/1.1 = $8,181.8181818182
Project 2: Initial investment is $1,000,000. One year cash flow is $1,250,000
IRR = 25%
NPV at 10% discount rate = -1,000,000 + 1,250,000/1.1 = $136,363.636363636
If we go by IRR rule we would accept project 1 because its IRR (100%) is greater than the IRR of project 2 (25%)
But, the dollar amount we would make is only $8,181.8181818182 from project 1.
Therefore, whenever IRR rule and NPV rule conflicts, we should always go with NPV rule. NPV rule is superior to any other rule
jeff jeffy answered 2 years agoRelated Solutions
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Cash Flows, per Year ($)
Project
0
1
2
3
4
A
(12,000)
5,000
5,000
5,000
5,000
B
(12,000)
Nil
Nil
Nil
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Initial
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Year
1 $130,000 $130,000
2 $120,000 $120,000
3 $130,000 $105,000
4 $200,000 $90,000
5 $250,000 $40,000
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You have been assigned the task of evaluating two mutually
exclusive projects with the following projected cash flows:
YEAR
PROJECT A
CASH FLOW
PROJECT B
CASH FLOW
0
−$110,000
−$110,000
1
30,000
0
2
30,000
0
3
30,000
0
4
30,000
0
5
30,000
220,000
(Click
on the icon located on the top-right corner of the data table
above in order to copy its contents into a
spreadsheet.)
If the appropriate discount rate on these...
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(CF 0CF0)...
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0 -105,000 -105,000
1 40,000 0
2 40,000 0
3 40,000 0
4 40,000 0
5 40,000 240,000
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year
Proj. A
Projc. B
Proj. C
0
$-500,000
$-350,000
$-700,000
1
$200,000
$100,000
$300,000
2
$200,000
$150,000
$300,000
3
$250,000
$200,000
$300,000
4
$250,000
$250,000
$300,000
Considering two mutually exclusive projects. The crossover rate between these two projects is ___ percent and...
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accepted if the required return is less than the crossover
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Year
Project A
Project B
0
−$27,000
−$27,000
1
10,000
18,100
2
10,000
8,000
3
18,000
10,120
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