7. Understanding the NPV profile If projects are mutually exclusive, only one project can be chosen. The internal rate of return (IRR) and the net present value (NPV) methods will not always choose the same project. If the crossover rate on the NPV profile is below the horizontal axis, the methods will agree. Projects W and X are mutually exclusive projects. Their cash flows and NPV profles are shown as follows Year Project W Project X $1,000$1,500 $350 $500 $600 $750 $200 $350 $400 $600 800 7. Understanding the NPV profile If projects are mutualy exclusive, only one project can be chosen. The internal rate of return (IRR) and the net present value (NPV) methods will not always choose the same project. If the crossover rate on the NPV profile is below the horizontal axis, the methods wi agree. always Projects W and X are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows sometimes never Year Project W Project X 0$1,000 $1,500 $200 350 $400 $600 $350 500 $600 $750 800 800 600 Project X 400 Project W 200 200 02 468 10 12 14 16 18 20 COST OF CAPITAL (Percent) 200 COST OF CAPITAL (Percent If the required rate of return for each project is 6%, do the NPV and IRR methods agree or conflict? The methods agree The methods conflict A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the ,and the IRR calculation assumes that the rate at which cash flows can be reinvested is the As a result, when evaluating mutually exclusive projects, the is usually the better decision criterion. 200 0 24610 12 14 16 18 20 COST OF CAPITAL (Percent lf the required rate of return for each project is 696, do the NPV and IRR methods agree or conflict? The methods agree The methods conflict A key to resolving this conflict is the assumed reinvestment rgt to. The NPY celculation implicitly assumes that intermediate cash flows are reinvested at the , and th! IRR method h assumes that the rate at which cash flows can be reinvested is the NPV method As a result, when evaluating mutually exclusive projects, the is usually the better decision criterion