Murray Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise Murray on the best procedure. If the wrong decision criterion is used, how much potential value would Murray lose? $\begin{array}{cccccc}
r&{1: 6.00 \%} & & & & \
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\mathrm{CF}_{\mathrm{S}} & -\$ 1,025 & \$ 380 & \$ 380 & \$ 380 & \$ 380 \
\mathrm{CF}_{\mathrm{L}} & -\$ 2,150 & \$ 765 & \$ 765 & \$ 765 & \$ 765
\end{array}$

Question

Quizplus · Accepted Answer

$\begin{array}{llllll}
WACC&{ 6.000 \%} & & & & \
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\mathrm{CF}_{\mathrm{S}} & -\$ 1,025 & \$ 380 & \$ 380 & \$ 380 & \$ 380 \
\mathrm{CF}_{\mathrm{L}}& -\$ 2,150 & \$ 765 & \$ 765 & \$ 765 & \$ 765 \
\Delta & -\$ 1,125 & \$ 385 & \$ 385 & \$ 385 & \$ 385
\end{array}$ 
 Crossover rate $ =13.86 \% $  $ \quad $$ \quad $ At interest rates $ < $ crossover rate, conflict exists. 
 $\begin{array} { l l } 
\mathrm { IRR } _ { \mathrm { L } } & 15.781 \% \
\mathrm { IRR } _ { \mathbf { S } } & 17.861 \% \
\
\mathrm { NPV } _ { \mathrm { L } } & \$ 500.81 \
\mathrm { NPV } _ { \mathbf { S } } & \$ 291.74 \
& \$ 209.07 = \text { Value lost if use the } \mathrm { IRR } \text { criterion }
\end{array}$ 
 $\begin{array}{lrr} 
&S&L\
& 291.7 & 500.8 \
0 \% & 495.0 & 910.0 \
2 \% & 421.9 & 762.9 \
4 \% & 354.4 & 626.9 \
6 \% & 291.7 & 500.8 \
8 \% & 233.6 & 383.8 \
10 \% & 179.5 & 274.9 \
12 \% & 129.2 & 173.6 \
13 \% 860 \% & 85.4 & 85.4 \
14 \% & 82.2 & 79.0 \
16 \% & 38.3 & -9.4 \
18 \% & -2.8 & -92.1 \
20 \% & -41.3 & -169.6 \
22 \% & -77.4 & -242.4 \
24 \% & -111.4 & -310.7
\end{array}$ 
Note that the WACC is constrained to be less than the crossover rate. So, there is a conflict between NPV and IRR; hence, following the IRR rule results in a loss of value. In the next problem the constraint is relaxed.

Murray Inc A) $18868 B) $198

Murray Inc A) $18868
B) $198