200488

CORPORATE FINANCIAL MANAGEMENT

Autumn 2009
Abbreviated Tutorial Exercise Solutions
Weeks 2-6

TUTORIAL WEEK 2

1. Find the interest earned over 3 years on an

investment of $3000 paying simple interest of 7.5%
per annum (p.a.).

Answer: $675

2. For the following investments find the compound

amount (future value) and total interest earned.
Assume no interest is withdrawn before the term of
the investment is reached.
(i) $10,000 over 6 years earning 5% p.a.
compounded annually.

FV6 = 10,000 (1 + 0.05) ≈ $13,400.96

6

Interest earned = $3,400.96

(ii) $6,000 over 4 years and 6 months earning 9%

p.a. compounded quarterly.
18
⎛ 0.09 ⎞
FVn = 6,000 ⎜1 + ⎟ ≈ $8,955.52
⎝ 4 ⎠

1
Interest earned = $2,955.52

(iii) $5000 over 2 years earning 10% p.a.

compounded daily. (Assume 365 days per
year)
730
⎛ 0.1 ⎞
FV2 = 5,000 ⎜1 + ⎟ ≈ $6,106.85
⎝ 365 ⎠
Interest earned = $1,106.85

3. Find the present value of $8,000 due in 5 years’

time at 10% per annum compounded monthly.
− ( 5×12 )
⎛ 0.1 ⎞
PV = 8,000 ⎜1 + ⎟ = $4,862.31
⎝ 12 ⎠

4. An amount of $6,000 is invested for a period of 6

years and earns interest at a rate of 12% per
annum compounded monthly. What is the
effective annual rate of interest earned on the
investment? Express your answer as a percentage
rounded to 2 decimal places.
12
⎛ 0.12 ⎞
EAR = ⎜1 + ⎟ − 1 ≈ 0.1268 (12.68%)
⎝ 12 ⎠

2
5. Gitman, Juchau and Flanagan (GJF, i.e. the
textbook), Problem 2-10 (p. 78).

“The balance sheet for Rogers Industries for 31

December 2006 is given below. Information
relevant to Rogers Industries’ 2007 operations is
given following the balance sheet. Using the data
presented:
(a) Prepare an income statement for Rogers
Industries for the year ended 31 December
2007. Be sure to show EPS.
(b) Prepare a balance sheet for Rogers Industries
for 31 December 2007.

Balance sheet ($000)

Rogers Industries
31 December 2006

Assets Liabilities and shareholders’ equity

Cash $40 Accounts payable $50
Marketable securities 10 Notes payable 80
Accounts receivable 80 Accruals 10
Inventories 100 Total current liabilities $140
Total current assets $230 Non-current debt $270

Non-current assets $890 Preference shares 40

Less Accumulated depn. 240 Ordinary shares 320
Net non-current assets $650 (80,00 shares)
Total assets $880 Retained earnings 110
Total shareholders’ equity $470

Total liabilities and $880

shareholders’ equity

3
Relevant Information
Rogers Industries
1. Sales in 2007 were $1.2 million.
2. Cost of goods sold equals 60% of sales.
3. Operating expenses equal 15% of sales.
4. Interest expense is 10% of the total beginning
balance of notes payable and non-current debts.
5. The firm pays 40% taxes on ordinary income.
6. Preference dividends of $4,000 were paid in
2007.
7. Cash and marketable securities are unchanged.
8. Accounts receivable equals 8% of sales.
9. Inventory equals 10% of sales.
10. The firm acquired $30,000 of additional non-
current assets in 2007.
11. Total depreciation expense in 2007 was
$20,000.
12. Accounts payable equals 5% of sales.
13. Notes payable, non-current debt and
shareholders’ equity were unchanged.
14. Accruals are unchanged.
15. Cash dividends of $119,000 were paid to
ordinary shareholders in 2007.”

4
(From solutions manual)

(a)
Rogers Industries
Income Statement
for the Year Ended 31 December 2007

Sales $1,200,000
Less: Cost of goods sold 720,000
Gross profit $ 480,000
Less: Operating expenses 180,000
Operating profits $ 300,000
Less: Interest expense 35,000
Net profits before taxes $ 265,000
Less: Taxes at 40% 106,000
Net profits after taxes $ 159,000
Less: Preference dividends 4,000
Earnings available to ordinary shareholders $155,000

Earnings per share (EPS) $1.9375

5
(b)
Rogers Industries
Balance Sheet
31 December 2007

Assets
Current assets:
Cash $ 40,000
Marketable securities 10,000
Accounts receivable 96,000
Inventories 120,000
Total current assets $ 266,000

Gross Non-Current assets $ 920,000

Less: Accumulated depreciation 260,000
Net assets $ 660,000

Total assets $ 926,000

6
Liabilities and shareholders' equity:
Current liabilities:
Accounts payable $ 60,000
Notes payable 80,000
Accruals 10,000
Total current liabilities $150,000
Non-Current debt 270,000
Total liabilities $420,000

Shareholders' equity
Preference shares $ 40,000
Ordinary shares 320,000
Retained earnings 146,000
($110,000+$155,000-$119,000)
Total shareholders' equity $506,000

Total liabilities and shareholders' equity $926,000

6. GJF, Problem 2-11 (p. 79)

“Hayes Enterprises began 2007 with a retained

earnings balance of $928,000. During 2007 the
firm earned $377,000 after taxes. From this
amount, preference shareholders were paid
$47,000 in dividends. At year-end 2007 the firm’s
retained earnings totalled $1,048,000. The firm
had 140,000 ordinary shares during 2007.
(a) Calculate retained earnings for the year ended
31 December 2007 for Hayes Enterprises.
(Note: Be sure to calculate and include the
amount of ordinary dividends paid in 2007)
(b) Calculate the firm’s 2007 EPS.

7
 (c) How large a per share cash dividend did the
firm pay on ordinary shares during 2007?”
(From solutions manual)
(a)
Ord. dividends = Net profits after taxes - preference dividends
- change in retained earnings
= 377,000 - 47,000 - (1,048,000 - 928,000)
= $210,000

Hayes Enterprises
Statement of Retained Earnings
for the Year Ended December 31, 2007

Retained earnings balance (January 1, 2007) $928,000

Plus:Net profits after taxes (for 2007) 377,000
Less:Cash dividends (paid during 2007)
Preference stock (47,000)
Ordinary (210,000)
Retained earnings (December 31, 2007) $1,048,000

(b)
377,000 − 47,000
Earnings per share =
140,000
= $2.36
(c)
210,000
Cash dividend per share = = $1.50
140,000

8
TUTORIAL WEEK 3

1. To achieve a savings goal of $15,000 in 3 years’

time, an individual decides to make 6 equal
deposits in a savings account at 6-monthly intervals
starting now. If the interest rate is 9% per annum
compounded semi-annually, what will each deposit
be?

i = 0.045

15,000 ⎡ 0.045 ⎤
PMT = = $2,137.01
(1 + 0.045) ⎢⎣ (1.045) 6 − 1⎥⎦

2. A firm currently has a debt of $120,000 that is to be

repaid by equal quarterly (3-monthly) payments at
the end of each quarter for the next 3 years, with
the first payment to be made one quarter from
now. If the interest rate is 12% per annum
compounded quarterly, answer the following:
(a) What will be the quarterly payment?
(b) What will be the principal outstanding
(amount owing) 2 years from now (i.e.
immediately after the eighth quarterly
payment is made)?

(a)
120,000 (0.03)
PMT = −12
= $12,055.45
1 − (1.03)

9
(b)

12,055.45[1 − (1.03) −4 ]
= $44,811.29
0.03

3. A firm’s managers wish to have $300,000 available

in 3 years’ time from now to allow for a planned
renovation of the firm’s factory at that time. To
accumulate this amount, the firm’s managers
decide to make equal monthly deposits into a fund
over the next 3 years. The fund earns interest of
12% per annum compounded monthly.
(a) Suppose 36 equal monthly deposits are made
into the fund, with the first deposit made
immediately (i.e. at t = 0 ). What should each
deposit be if there is to be $300,000 in the fund
in 3 years’ time? (No withdrawal is made
from the fund over the 3-year period)
(b) Suppose that instead, only 30 equal monthly
deposits are made into the fund, with the first
deposit made in 7 months’ time. What should
each deposit be now if there is still to be
$300,000 in the fund in 3 years’ time from
now? (Again no withdrawal is made from the
fund until the end of 3 years from now).

10
(a)
PMT [(1 + 0.01)36 − 1](1.01)
300,000 =
0.01
PMT = $6,895.34
(b)
PMT [(1 + 0.01)30 − 1]
300,000 =
0.01
PMT = $8,624.43

4. A football association wishes to create a perpetual

prize of $50,000 each year for the ‘best and fairest’
player in its football competition by making an
immediate investment. Supposing an interest rate
of 8% per annum compounded annually, how
much money will the association need to fund the
annual prize now if the prize is first awarded: (a) in
one year's time, (b) two years from now? (Assume
that the prize will indeed be awarded at yearly
intervals subsequent to the first award being made)

(a)

50,000
PVA∞ = = $625,000
0.08

(b)
625,000 (1.08) = $578,703.70
−1

11
5. In order to replace a machine in the future, a firm
plans to deposit 10 equal amounts into a fund at
yearly intervals so that the amount in the fund will
be $30,000 when the 10th (last) deposit is made.
Initially the fund earns 8% per annum
compounded annually, however after 4 years the
interest rate unexpectedly increases to 9% per
annum compounded annually. If the firm reduces
its annual deposit to take account of the higher
interest rate, what will be the new annual payment
for the last 6 years? (Hint: Proceed by first
calculating the regular deposit amount under the
initial conditions, then the amount in the fund once
the fourth deposit is made, then the new deposit
after four years)

Initial yearly payment = PMT1

FVA × i1 30,000 (0.08)
PMT1 = = = $2,070.88
[(1 + i1 ) n − 1] (1.08)10 − 1

Amount in the sinking fund after 4 years

2,070.88 [(1.08) 4 − 1]
= = $9,331.62 = FVA1
0.08

9,331.62 (1.09) 6 = $15,650.06 = FVA2 after 10 years

Let
30,000 − FVA2 = 30,000 − 15,650.06 = $14,349.94 = FVA3

12
 0.09 (14,349.94)
PMT2 = = $1,907.39
(1.09) − 1
6

13
TUTORIAL WEEK 4

1. GJF, Review Question 5-7 (p. 218)

“When is the coefficient of variation preferred over

the standard deviation for comparing asset risk?”

See text/lecture notes

2. GJF, Review Question 5-11 (p. 237)

“How are total risk, non-diversifiable risk and

diversifiable risk related? Why is non-diversifiable
risk the only relevant risk?”

See text/lecture notes

3. GJF, Problem 5-4 (p. 241)

“Sharon Smith, the financial manager for Barnett

Corporation, wishes to evaluate three prospective
investments –X, Y and Z. Currently the firm earns
12% on its investments, which have a risk index of
6%. The three investments under consideration
are profiled below in terms of expected return and
expected risk.

14
 Investment Expected Return Expected risk
index
X 14% 7%
Y 12 8
Z 10 9

(a) If Sharon were risk-indifferent, which

investments would she select? Why?
(b) If Sharon were risk-averse, which investments
would she select? Why?
(c) If Sharon were a risk-seeker, which
investments would she select? Why?
(d) Given the traditional risk preference
behaviour exhibited by financial managers,
which investments would be preferred? Why?

(From solutions manual)

(a) The risk-indifferent manager would accept
Investments X and Y because these have the same or
higher returns than the 12% required return and the
risk doesn’t matter.

(b) The risk-averse manager would accept Investment X

because it provides the highest return and has the
lowest amount of risk. Investment X offers an
increase in return for taking on more risk than what
the firm currently earns. (Although there is nothing in
the question that allows us to assess whether this
increase in return is sufficient to compensate for the
increased risk)
15
(c) The risk-seeking manager would accept Investments Y
and Z because he or she is willing to take greater risk
without an increase in return.

(d) Traditionally, financial managers are risk-averse and

would choose Investment X, since it provides the
required increase in return for an increase in risk.

4. The numbers below represent the annual return in

% earned on shares held in a particular company
for the 8 successive years. Considering these
returns as a sample of returns on the shares,
calculate the sample mean return and the sample
standard deviation of the returns. Round your
answer to 4 decimal places, if necessary.

4.5, 8, 9.6, 2.3, 0.5, 2.8, 4, 8.3

(Sample) mean return (= k ) = 5

(Sample) standard deviation of returns

n

∑ (k i − k ) 2
σk = i =1

n −1
≈ 3.2663

16
5. In the following table, returns to two assets (A and
B) are given for different states of nature with the
stated probabilities of occurring. Calculate the
expected (mean) return, standard deviation of
returns and coefficient of variation of returns for
each asset. Which asset would be considered more
risky?

State of Nature Probability Return A Return B

(1) 0.20 23% 9%
(2) 0.35 11% 6%
(3) 0.40 7% -3%
(4) 0.05 19% -6%

For asset A:
k = 12.2%
For asset B:
k = 2.4%

For asset A:
σ = 36. 96 ≈ 6.0795%

For asset B:
σ = 28.44 ≈ 5.3329%

For asset A:
cV ≈ 0.4983
For asset B:
cV ≈ 2.2220

17
6. Given the same information as in question (5)
above, calculate the expected return and standard
deviation of the following two portfolios with
weights as given. (Hint: Start by calculating the
return to each portfolio under each state of nature)

Portfolio Asset A Weight Asset B Weight

X 0.40 0.60
Y 0.64 0.36

For portfolio X:
k p = 0.4 (12.2) + 0.6 (2.4) = 6.32%
For portfolio Y:
k p = 8.672%

Then, using the hint.

State of nature Portfolio X Portfolio Y

Return (%) Return (%)
(1) 14.60 17.96
(2) 8.00 9.20
(3) 1.00 3.40
(4) 4.00 10.00
k p (%) 6.32 8.672
σ p (%) 5.1273 5.3439

18
7. The following table shows the returns (in percent)
on ordinary shares A and B in three possible states
of nature, together with the probabilities of these
states of nature occurring.

State of Probability Return on Return on

Nature A (%) B (%)
Recession 0.2 4 12
Normal 0.4 6 5
Boom 0.4 8 2

With reference to the above table:

(a) Calculate the expected return and standard
deviation of returns for A shares and for B
shares (separately).
(b) If a risk averse investor had to choose between
holding A shares and holding B shares, which
would he/she choose. Give a reason for your
answer.
(c) If an investor were to form a portfolio
consisting of A and B shares, would it be
possible for the portfolio to offer a lower
standard deviation of returns than both A and
B shares, and an expected return that is not
lower than the expected returns of both
shares? Give a reason for your answer (Hint:
you should be able to give a reason for your
answer without having to perform any further
calculations)

19
(i)
k = 0.2(4) + 0.4(6) + 0.4(8) = 6.4
k B = 0.2(12) + 0.4(5) + 0.4(2) = 5.2
σ A = 0.2(4 − 6.4) 2 + 0.4(6 − 6.4) 2 + 0.4(8 − 6.4) 2 = 2.24 ≈ 1.50%
σ B = 0.2(12 − 5.2) 2 + 0.4(5 − 5.2) 2 + 0.4(2 − 5.2) 2 = 13.36 ≈ 3.66%

(ii) A risk averse investor would prefer A shares.

(iii) No it would not be possible to form a portfolio

consisting of the two assets that satisfies both
requirements. Certainly, from the table of returns we
see that the returns on the two shares are negatively
correlated, which means that they may be combined
to give a portfolio with a lower standard deviation of
returns than that of the asset (share A) with the lower
standard deviation of returns. However, the expected
return on any portfolio consisting of positive amounts
of both A and B shares will be between the expected
returns on the individual shares, therefore it could not
be lower than the expected returns of both shares.

20
 TUTORIAL WEEK 5

1. GJF, Review Question 5-14 (p. 237)

See text/lecture notes

2. The expected return on a portfolio of shares is

8.9% per annum and the portfolio has a beta of 1.3.
If the expected return on the market portfolio is 8
per annum and the assumptions of the capital asset
pricing model hold, what is the annual risk free
rate of interest? Also state what the market risk
premium is.

From the security market line

8.9 = rF + 1.3 (8 − rF )
rF = 5%
Market risk premium = 3%

3. Suppose a share in CFM Incorporated is expected

to be worth $50 in three years’ time. The expected
return on the market portfolio is 8% per annum,
the risk free rate is 5% per annum, and the beta of
UWS Incorporated shares is 1.75. Assuming the
CAPM is valid and that no dividends are expected
to be paid over the next three years, how much
should you be willing to pay for one CFM Inc.
share now?

21
From the security market line, the expected rate of return
on the shares is
k j = 0.1025 (10.25%)
You should be willing to pay (per share)
50
P0 = = $37.31
(1 + 0.1025) 3

4. (a) State what is meant by the term structure of

interest rates and the yield curve.
(b) Distinguish between interest rate risk and
default risk.

See text/lecture notes

5. A particular issue of government bonds has a per

bond face value of $1,000, a coupon rate of 7.5%,
and mature in 20 years’ time. If the current yield
to maturity is 9.5% and the bonds pay interest
annually, what is the current price of these bonds?

We have
75[1 − (1 + 0.095) −20 ] 1,000
B0 = +
0.095 (1 + 0.095) 20
= $823.75

22
6. The oldest issue of Auston Incorporated bonds
mature in one year’s time when the final annual
coupon of $60 will be paid together with the par
(face) value of $1,000 per bond.
(a) What is the current annual yield on these
bonds if their current price is $950? Express
your answer as a percentage correct to two
decimal places (as there is only one year
involved, this can be calculated by hand).
(b) If instead the bonds paid semi-annual coupons
but still had the same effective annual yield as
in (i), what would be the bond’s annual yield
quoted in the financial press? Express your
answer as a percentage correct to two decimal
places.

(i)
We have
I M
B0 = +
1 + kd 1 + kd
I +M 60 + 1,000
kd = −1 = − 1 = 0.1158
B0 950
or 11.58%

(ii)
(1 + k d 2) 2 − 1 = 0.1158
k d = 0.1126
or 11.26%

23
7. An opal mining company has known resources that
are being depleted at a constant rate, resulting in a
constant fall in earnings and dividends of 6% per
annum. The company’s current dividend is $10
per share and investors require a return of 12% on
the company’s shares. What is the current price of
the firm’s shares?

We use the constant dividend growth (Gordon) model

10(1 − 0.06)
P0 = = $52.22
0.12 − ( −0.06)

8. The ordinary share annual dividend of the ABC

Corporation is expected to grow by 4% per annum
over the next 3 years and at a constant rate of 1%
per annum thereafter. If the latest dividend (just
paid) is $5 per share, what is the maximum amount
an investor who has these expectations would be
prepared to pay now for one of the firm’s ordinary
shares if she requires a return of 8% per annum?

We use the variable dividend growth model:

5 (1.04) 5 (1.04) 2 5 (1.04) 3 1 ⎛ 5 (1.04) 3 (1.01) ⎞

P0 = + + + ⎜ ⎟
1.08 (1.08) 2
(1.08) 3
(1.08) ⎝ 0.08 − 0.01 ⎠
3

= $78.34

24
TUTORIAL WEEK 6

1. A company involved in the production of HIV

(human immunodeficiency virus) blood tests is
considering bringing in a new type of test that is
slightly different from its currently marketed test.
For the project involving introduction of the new
test, which of the following costs are relevant for an
analysis of whether the new test should be
introduced?
(a) $1.2 million spent last year on research and
development of the new test.
(b) An increase in annual marketing costs of
$800,000 if the new test is introduced.
(c) A drop in annual sales of the existing test of
$2.4 million if the new test is introduced.
(d) Laboratory facilities already owned by the
company that could be used to produce the
test and are currently valued at $1.5 million.

Only (b) and (c) would be included in the calculation of

relevant incremental cash flows.

2. Give definitions of the following:

(a) Conventional projects
(b) Incremental net cash flows

See text/lecture notes

25
3. GJF, Problem 8-18 (p. 376)

“Cushing Limited is considering the purchase of a

new grading machine to replace the existing one.
The existing machine was purchased three years
ago at an installed cost of $20,000. It was being
depreciated using the prime cost method with an
effective life of five years. The existing machine is
expected to have a usable life of at least five more
years. The new machine costs $35,000 and requires
$5,000 in installation costs. It will be depreciated
using the prime cost method over five years. The
existing machine can currently be sold for $25,000
without incurring any removal or clean-up costs.
The firm pays 40% taxes on both ordinary income
and capital gains. Calculate the initial investment
associated with the proposed purchase of a new
grading machine.”

(From solutions manual)

Installed cost of new asset =
=35,000 + 5,000 = $40,000 (depreciable value)

Book value of existing machine =

⎛ ($20,000 × 3) ⎞
$20,000 – ⎜ ⎟ = $8,000
⎝ 5 ⎠

26
From the sale of the existing machine, we would have:

Recovered depreciation = 20,000 – 8,000 = $12,000

Capital gain = 25,000 – 20,000 = $5,000

Tax on recovered depreciation = $12,000 × (0.40) = 4,800

Tax on capital gain = 5,000 × (0.40) = 2,000

Total tax on sale of existing machine

= 4,800 + 2,000= $6,800

Hence:
After-tax proceeds from sale of old asset =
= 25,000 - 6,800 = $18,200

Initial Investment =
= 40,000 – 18,200 = $21,800

4. Suppose a company is considering an expansion

project requiring an initial investment of
$1,500,000. The project has a life of 10 years and
the initial investment amount would be depreciated
fully over the life of 10 years using straight line
(prime cost) depreciation. The firm faces a
company tax rate of 30%. Based on the following
information that relates exclusively to this project
in year 4 of its life, calculate the relevant year 4
incremental after tax cash flow of this project for
capital budgeting purposes.

27
 Annual sales 50,000 units at $50 per unit
Variable costs $12 per unit
Fixed costs $350,000 per annum
Interest expense $120,000 per annum

We have, for the fourth year:

Sales (50,000×50) 2,500,000

-Variable Costs (50,000×12) -600,000
-Fixed Costs -350,000
-Depreciation (0.1×1,500,000) -150,000
Pre-Tax Income 1,400,000
-Taxes (0.3×1,400,000) -420,000
Net Operating Income 980,000
Net Cash Flow 1,130,000

The relevant net cash flow is $1,130,000.

5. GJF, Problem 8-27 (p. 378)

“Russell Industries Limited is considering

replacing a fully depreciated machine having a
remaining useful life of 10 years with a newer,
more sophisticated machine. The new machine will
cost $200,000 and require $30,000 in installation
costs. It will be depreciated using the prime cost
method over an effective life of five years. A
$25,000 increase in net working capital will be
required to support the new machine. The firm
plans to evaluate the potential replacement over a
four-year period. They estimate that the old
28
 machine could be sold at the end of four years to
net $15,000 before taxes; the new machine at the
end of four years will be worth $75,000 before
taxes. Calculate the terminal cash flow relevant to
the proposed purchase of the new machine. The
firm is subject to a 40% tax rate.”

(From solutions manual)

Book value of new machine after 4 years = $46,000

New Old
Proceeds from sale $75,000 $15,000
less Book value 46,000 0
Profit on sale of asset 29,000 15,000
Tax liability at 40% (11,600) (6,000)

Proceeds from sale 75,000 15,000

less Tax liability (11,600) (6,000)
Terminal cash flow 63,400 9,000

Terminal cash flow (new machine) 63,400

less Terminal cash flow (old (9,000)
machine)
Plus recovery of working capital 25,000
Incremental terminal cash flow 79,400

29
6. Calculate the NPV of the following net cash flows if
the cost of capital is 12% per annum. Also
calculate the payback period (assuming cash
inflows occur evenly each year).

Year Net Cash Flow ($)

0 -50,000
1 10,000
2 32,000
3 30,000
4 -5,000

NPV = $2,614.59
8
Payback period = 2 + ≈ 2.27 years.
30

7. Briefly discuss the advantages and disadvantages

of the Net Present Value and Internal Rate of
Return methods of project evaluation. Do these
methods always lead to consistent
recommendations? If not, why not?

See text/lecture notes

30
8. Mish Mash Pty. Ltd. wishes to choose between two
mutually exclusive projects, A and B, each giving
only one positive net cash flow at the end of one
year, as per the following table.

Net Cash Flows

Year 0 Year 1
Project A -400 500
Project B -200 280

Determine the IRR for each project manually by

equating the NPV to zero and solving for the
discount rate. Determine the cost of capital at
which the firm should be indifferent between the
two projects and give a rough sketch of the NPV
profiles of the projects. Under what circumstances
will choosing the project with the higher IRR give
the best outcome for the firm’s shareholders?

500
− 400 = 0
1 + IRR
IRR = 0.25
Thus the IRR for project A is 25%

280
− 200 = 0
1 + IRR
IRR = 0.40
Thus the IRR for project B is 40%

31
The cost of capital at which the firm should be indifferent
between the two projects is the discount rate for which the
NPVs are equal.

500 280
− 400 = − 200
1+ k 1+ k
k = 0.10
This is the discount rate at which the projects’ NPV profiles
will cross.

Diagrammatically:

NPV

100
Project A
80

Project B

0 10% 25% 40%

Cost of Capital

32