Question

Swenson's is considering two mutually exclusive projects, Projects A and B, and has determined that the crossover rate for these projects is 11.7 percent and the required return for both projects is 9 percent. Given this you know that:

Multiple Choice

• both projects have a zero NPV at a discount rate of 11.7 percent.

• neither project will be accepted if the discount rate is less than 11.7 percent.

• the project that is acceptable at a discount rate of 11 percent should be rejected at a discount rate of 12 percent.

• both projects have a negative NPV at discount rates greater than 11.7 percent.

• both projects provide an internal rate of return of 11.7 percent.

Answer 1

Crossover rate is the rate at which the NPV of the two projects is equal. For rates lower than this, one project is better than the other and for rate higher than this the other projects becomes better till the time NPV remains positive.

At the crossover rate, the investor is indifrrent between the two projects if the NPV is positive for both the projects.

Having understood this let's look at the options:

• Both project might have 0 NPV at the crossover rate but it is not always true and is not being implied by the given information or the definition of the crossover rate. So this option is incorrect.

• If any one project has a positive NPV at the rate lower than the crossover rate, it can be selected if this NPV is higher than that of the other project. So this option is also incorrect.

• As explained in the definition, one project is acceptable at rates below the crossover rate and the other project is accepted at a rate higher than the crossover rate. So if the crossover rate is 11.7% then one project will have a higher NPV at 11% and the other will have a highe NPV at 12% so this statement is correct

• This is not at all implied by the crossover rate. It only implies that the NPV is equal. So this option is incorrect.

• Even this is not implied by the crossover rate, IRR is the rate at which the NPV = 0, it is not the rate at which the NPV becomes equal for both the projects. So this option is incorrect.