Question

Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (in millions of dollars) would be as follows:

Time	0	1	2	3	4
Project A	-$30	$5	$10	$15	$20
Project B	-$30	$20	$10	$8	$6

e) The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice between mutually exclusive projects.

f) Define the MIRR. What’s the difference between the IRR and the MIRR, and which generally gives a better idea of the rate of return on the investment in a project? Explain

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Answer 1

1.

The crossover rates for the two Projects are stated to be 13.5252%

Crossover rate is the cost of capital at which the net present values of two projects are equal. It is the point at which the NPV profile of one project crosses over (intersects) the NPV profile of the other project.

At crossover both projects have same npv.

CROSSOVER NPV = 4.45 in this case.

Here is the choice is as follows:

MIRR

MIRR is an improved version of the internal rate of return ( IRR), which measures a rate of reinvestment and even or unequal cash flows of accounts. In reality, MIRR represents the cost and profitability of a project more accurately than IRR because it considers the cost of capital as the reinvested rate for the positive cash flows of a firm, and the cost of investment as the discount rate for the negative cash flows of the firm.

MIRR = (Future value of positive cash flows / present value of negative cash flows) (1/n) – 1.

• future value of the positive cash flows discounted at the cost of capital.
• the present value of the negative cash flows discounted at the financing cost.

MIRR calculation is usually useful when project have multiple cash outflows throughout their lives and as such we get more than one values of IRR.