Question
A 4-year project, X, with an upfront cost of $20 million is expected to yield the following series of cash flows: $3.60 million in year
A 4-year project, X, with an upfront cost of $20 million is expected to yield the following series of cash flows: $3.60 million in year one, $4.20 million in year two, $5.70 million in year three, and $7.80 million in year four. At the end of year four, the project assets will be liquidated and sold for a net cash flow of $9.20 million. The required rate of return on the project is 14%. Now assume that we have another project, Y, mutually exclusive with X requiring the same rate of return with the following cash flows: initial outlay $20 million, expected cash flows for the next four years: $10.80 million, $6.80 million, $4.30 million, and $7.20 million respectively.
- Calculate the cross-over rate of the two projects.
- If we assume that the RRR on the two projects is below the rate calculated in part, c above, would the IRR be a proper decision criterion? Why or why not?
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