Date: June 1, 2008 04:07PM
what is crossover rate. What is its significance?
Date: June 1, 2008 04:10PM
is the rate at which 2 projects have the same NPV
Date: June 1, 2008 04:17PM
simultaneous consitency ...
Date: June 1, 2008 04:22PM
It's the rate when IRR and NPV start to give different answers. Say, two investments have positive IRR's, IRRa =12%, and IRRb=15%, with NPVa=$100k, and NPVb=$50k, with both having a cost of capital of 10%.
A problem can occur if the two investments are multually exclusive, i.e., you can't take both, just pick one. Which one should you pick? Investment B has the higher IRR, but the lower NPV, so if you followed IRR you will go with B. If you follow NPV you will go with A. Whom should you believe?
You would normally take A because it has the highest NPV, but not always. You have to consider the cross-over rate, which is the rate (say 8%) when project B (the lower NPV investment) becomes the better option. So, both IRR and NPV will agree on the same decision only when the cost of capital is *greater than* the cross over rate.