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23 August, 12:37

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

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  1. 23 August, 13:06
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    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
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