Question

Part a - Langton Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone? In other words, what's the NPV of the chosen project versus the maximum possible NPV? You must show each project's IRR as well as its NPV. The firm's cost of capital is 7%.

part b. What is the crossover point for the two projects? What is the significance of this?

Year	CF from S	CF from L
0	-1200	-2650
1	550	725
2	700	750
3	200	800
4	300	1400

Answer 1

	Year	CF from S	CF from L	PVIF @ 7%	present value S	present value L	Cash flow delta
	0	-1200	-2650	1	(1,200.00)	(2,650.00)	-1450
	1	550	725	0.934579439	514.02	677.57	175
	2	700	750	0.873438728	611.41	655.08	50
	3	200	800	0.816297877	163.26	653.04	600
	4	300	1400	0.762895212	228.87	1,068.05	1100
					317.55	403.74
IRR S =		20.25%
IRR L =		12.87%
NPV S		317.55
NPV L=		403.74
Therefore Amount forgone =	86.19
Cross over rate =			8.89%
At cross over rate both the project will have same NPV.