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

The answer is 30%

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