CFA Practice Question
For two mutually exclusive capital projects with normal cash flows, the NPV and IRR methods will most likely produce conflicting rankings when the:
A. cost of capital is greater than the crossover rate.
B. cost of capital is equal to the crossover rate.
C. cost of capital is less than the crossover rate.
Explanation: The NPV and IRR methods lead to conflicting decisions when the cost of capital is less than the crossover rate.
User Contributed Comments 7
| User | Comment |
|---|---|
| jpducros | When cost of capital is less than the crossover rate, both NPV and IRR of A will be over NPV and IRR of B, or the opposite...but this is not a conflict. You'll chose the highest. Can someone explain ? |
| chantal | NPV assumes cash flows are reinvested at cost of capital. Il such increase, the NPV with steeper value will be most affected. Above the crossover rate, the NPV change and reverse. See graph LOS40 e |
| jpducros | I think you meant LOS 44e. I still don't understand. |
| arudkov | look: A has steeper NPV profile (Higher NPV when r=0, lower IRR). If r<crossover - A will have higher NPV & lowerIRR - this means conflict; If r>crossover - A will have lower NPv & lower IRR (that means that B @ the same time will have higher NPV&IRR) - so here is no conflict. |
| arudkov | one thing - i failed to answer this Q for 90 seconds)) |
| tzanchan | draw an NPV profile and the answer will be clear to you. |
| longnh9 | ty arudkov |