2.2 Comparison of NPV and IRR: Some Technical Points
In certain circumstances, the analyst will find that the choice amongst two competing projects will depend on how high or low the discount rate is when utilizing the NPV and IRR methods. For instance, you are given the free cash flows for the two projects, A and B, as below. For each, resolve the questions below.
| Project A | Project B | |
| 0 | ($300) | ($405) |
| 1 | (387) | 134 |
| 2 | (193) | 134 |
| 3 | (100) | 134 |
| 4 | 600 | 134 |
| 5 | 600 | 134 |
| 6 | 850 | 134 |
| 7 | (180) | 0 |
| Rates | NPV Profiles for | |
| Project A | Project B | |
| 0.0 | ||
| 10.0 | ||
| 12.0 | ||
| 18.1 | ||
| 20.0 | ||
| 24.0 | ||
| 30.0 |
This NPV Profiles worksheet provides room for the final NPV number only; it does not allow space for the calculations needed to arrive at the NPVs for each different discount rate. You may, therefore, wish to create a spreadsheet similar to that, which was used for “Uneven Cash Flows” in order to complete this exercise.
Questions Coming up:
- What are the IRRs for each project?
- What is the “crossover rate” for projects A and B?
- The crossover rate is the discount rate at which the NPVs of each project will be the same.
- What is the significance of the “crossover rate”?
- Construct a diagram of the two projects’ respective NPVs as they vary across discount rates. This will illustrate visually the crossover rate. (See NPV Profiles Illustrated below.)
- If the reinvestment rate is 12%, what are the MIRRs for each project?