Answer :
Final answer:
The crossover rate, calculated by subtracting cash flows of one project from another and finding the IRR, dictates which project is more profitable based on the actual discount rate. If the discount rate is less than the crossover rate, choose the project with higher initial and lower late cash inflows. If the discount rate is greater than the crossover rate, choose the project with lower initial and higher late cash inflows.
Explanation:
In financial management, the crossover rate is the cost of capital at which the Net Present Values (NPVs) of two projects are equal. This is an important concept when comparing mutually exclusive investments as it shows the rate at which one project becomes more profitable than another.
To calculate the crossover rate, subtract the cash flows of one project from another for each period, and calculate the IRR of the resulting series. In this case, subtract the cash flows of Project B from Project A and calculate the IRR for the resultant cash flows. Then find the discount rate at which this project has an NPV of zero, which is the crossover rate.
If the actual cost of capital (discount rate) is less than the crossover rate, the project with higher initial cash outflows and smaller late period cash inflows should be chosen (typically, Project A). On the other hand, if actual cost of capital is greater than the crossover rate, the project with lower initial cash outflows and higher late period cash inflows (typically, Project B) is more profitable.
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