Markman & Sons is considering Projects S and L. These projects are mutually exclusive, equally risky, and not repeatable and their cash flows are shown below. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, i.e., no conflict will exist. $\begin{array}{cccccc}
{r}{: 10.00 \%} & & & \
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\mathrm{CF}_{\mathrm{S}} & -\$ 1,025 & \$ 650 & \$ 450 & \$ 250 & \$ 50 \
\mathrm{CF}_{\mathrm{L}} & -\$ 1,025 & \$ 100 & \$ 300 & \$ 500 & \$ 700
\end{array}$

Question

Quizplus · Accepted Answer

$\begin{array}{lccccc}
\text { WACC: } & 10.000 \% & & & & \
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\mathrm{CF}_{\mathrm{S}} & -\$ 1,025 & \$ 650 & \$ 450 & \$ 250 & \$ 50 \
\mathrm{CF}_{\mathrm{L}} & -\$ 1,025 & \$ 100 & \$ 300 & \$ 500 & \$ 700 \
\Delta & \$ 0 & -\$ 550 & -\$ 150 & \$ 250 & \$ 650
\end{array}$ 
 $\text { Crossover rate }=10.549 \% \quad \text { At interest rates }<\text { crossover rate, conflict exists. }$ 
 $\begin{array} { l l } 
\mathrm { IRR } _ { \mathrm { L } } & 15.66 \% \
\mathrm { IRR } _ { \mathbf { S } } & 19.86 \% \
\
\mathrm { NPV } _ { \mathrm { L } } & \$ 167.61 \
\mathrm { NPV } _ { \mathbf { S } } & \$ 159.79  \
&\$ 7.82= \text { Value lost if use the } \mathrm { IRR } \text { criterior }\
\end{array}$ 
Note that the WACC is not constrained to be less than the crossover rate. So, there may not be a conflict between NPV and IRR; hence, following the IRR rule may not result in a loss of value. In that case, the correct answer is $0.00.

Markman & Sons Is Considering Projects S and L A) $547 B) $6

Markman & Sons Is Considering Projects S and L A) $547
B) $6