*This preview shows
page 1. Sign up to
view the full content.*

**Unformatted text preview: **,000
$500
$100
$4 00
$300
$300
$4 00
$100
$600 Year
0
1
2
3
4 WACC = 10.0%
Project S Project L
NPV =
$78.82
$ 4 9.18
IRR =
14 .4 9% 11.79%
Crossover = 7.17% Pro jec t S's
N PV P ro f ile Data Table used to make g raph:
Project NPVs
S
L
WACC
$78.82
$ 4 9.18
0%
$300.00 $4 00.00
5%
$180.4 2 $206.50
7.17%
$134 .4 0 $134 .4 0
10%
$78.82
$4 9.18
11.79%
$4 6.10
$0.00
14 .4 9%
$0.00 -$68.02
15.0%
-$8.33 -$80.14
20%
-$83.72 -$187.50
25%
-$14 9.4 4 -$277.4 4 Bo t h P ro ject s ' P ro f iles $200 $10 0 Conflict NPVs
Accept No conflict NPV L Reject Crossover IRRS = 1 4.49% = 7 .17% $0
0% % 5% 10 % 1 5% 20% 25 % $0
0% 5% 1 0% 15% 20% 25% WACC WACC Points about the g raphs:
1. In Panel a, we see that if WACC < IRR, then NPV > 0, and vice versa.
2 . Thus, for "normal and independent" projects, there can be no conflict between NPV and IRR ranking s.
3. However, if we have mutually exclusive projects, conflicts can occur. In Panel b, we see that IRR S is
always greater than IRRL, but if WACC < 11.56%, then IRRL > IRRS, in which case a conflict occurs.
4 . Summary: a. For normal, independent projects, conflicts can never occur, so either method can be used.
b. For mutually exclusive projects, if WACC > Crossover, no conflict, but if WACC < Crossover,
then there will be a conflict between NPV and IRR. Previously, we had discussed that in some instances the NPV and IRR methods can give conflicting results. First, we
should attempt to define what we see in this graph. Notice, that the two project profiles (S and L) intersect the x-axis
at costs of capital of 14% and 12%, respectively. Not coincidently, those are the IRR's of the projects. If we think
about the definition of IRR, we remember that the internal rate of return is the cost of capital at which a project will
have an NPV of zero. Looking at our graph, it is a logical conclusion that the IRR of a project is defined as the point
at which its profile intersects the x-axis.
Looking further at the NPV profiles, we see that th...

View Full
Document