Corporate Finance

neha.kapoor318
Posts: 9
Joined: Sat Jun 07, 2014 7:14 am

Corporate Finance

Postby neha.kapoor318 » Mon Aug 11, 2014 6:14 am

Consider the two projects below. The cash flows as well as the NPV and the IRR for the two projects are given. For both projects, the required rate of return is 10 %.
Year 0 1 2 3 4 NPV IRR(%)
Project 1 -100 36 36 36 36 14.12 16.37%
Project 2 -100 0 0 0 175 19.53 15.02%

What discount rate would result in the same NPV for both projects?
A) A rate between 0.00 percent and 10.00 percent
B)A rate between 10.00 percent and 15.02 percent
C) A rate between 15.02 percent and 16.37 percent

Request to please explain it as i could not understand the answers and reason to it?

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Corporate Finance

Postby edupristine » Mon Aug 11, 2014 8:46 am

Here we need to calculate crossover rate ( i.e IRR of Synthetic cash flows made by differences of project cash flows).
-100 – (-100) = 0 <- Year 0 (difference)
36 – 0 = 36 <- Year 1 (difference)
36 – 0 = 36 <- Year 2 (difference)
36 – 0 = 36 <- Year 3 (difference)
36 – 175 = -139 <- Year 4 (difference)
Now put the values.
CF0 = 0
CF1 = 36
CF2 = 36
CF3 = 36
CF4 = -139
Solve for IRR. It will return 13.16%, which is the ratio provided by the key answer.
The correct answer is B.


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