2.5 The Solution Explained: A Retrospective Bird’s Eye View
The discount rate, based on the company’s cost of capital, may be somewhat arbitrary as it is subject to fluctuating market conditions. If the crossover point is 14.53% (as above) and the firm’s discount rate cost of capital is either 14.4% or 14.6%, we would technically favor one or the other project, but just barely. As such, the exact location of the crossover point is, possibly, of great interest. This crossover point “phenomenon” will occur when we are faced with competing projects whose idiosyncratic comparative NPV profiles emanate from radically different cash flow “complexions” – as we saw in the example just completed.
So… what do we already know, and how will it help us in calculating the crossover point? We know that the IRR is the point at which the NPV = 0 for any given project. That is useful.
The fictitious “Project C” represents the difference in the two projects’ respective cash flows. Thus, the IRR for “C” would represent the difference between the two projects’ NPVs. In other words, NPVA – NPVB = 0, and IRRC must will, at this point, equal 0.1453!