Question

Suppose you are evaluating two mutually exclusive projects, A and B. Project A costs $350 and has cash flows of $250 and $250 in the next 2 years, respectively. B costs $300 and generates cash flows of $300 and $100. What is the crossover rate for these projects

Answer 1

The answer is 30%

Step-by-step explanation:

Solution

Given that:

Project A

Project A costs = $350

Cash flows =$250 and $250 (next 2 years)

Project B

Project B costs =$300

Cash flow = $300 and $100

Now what is the crossover rate for these projects.

Thus

Year Project A Project B A-B B-A

0 -350 -300 -50 50

1 250 300 -50 50

2 250 100 150 -150

IRR 27% 26% 30% 30%

So,

CF = CF1/(1+r)^1 + CF2/(1+r)^2

$-50 = $-50/(1+r)^1 + $150/(1+r)^2

r = 30%

CF = CF1/(1+r)^1 + CF2/(1+r)^2

$50 = $50/(1+r)^1 + $-150/(1+r)^2

r = 30%

Hence, the cross over rate for these project is 30%

Note:

IRR =Internal rate of return

CF =Cash flow

r = rate