This example illustrates that when we have mutually exclusive projects, we shouldn't rank them based on their returns. More generally, anytime we are comparing investments to determine which is best, looking at IRRs can be misleading. Instead, we need to look at the relative NPVs to avoid the possibility of choosing incorrectly. Remember, we're ultimately interested in creating value for the shareholders, so the option with the higher NPV is preferred, regardless of the relative returns.

If this seems counterintuitive, think of it this way. Suppose you have two investments. One has a 10 percent return and makes you $100 richer immediately. The other has a 20 percent return and makes you $50 richer immediately. Which one do you like better? We would rather have $100 than $50, regardless of the returns, so we like the first one better.

Calculating the Crossover Rate

In Figure 9.8, the NPV profiles cross at about 11 percent. How can we determine just what this crossover point is? The crossover rate, by definition, is the discount rate that makes the NPVs of two projects equal. To illustrate, suppose we have the following two mutually exclusive investments:


Investment A

Investment B

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