After eliminating the right-of-way cash flows at Rotterdam, how do the Merseyside and Rotterdam projects compare financially and along other dimensions?
After eliminating the right-of-way cash flows, the Merseyside and Rotterdam projects have relatively more credible NPV figures, and it exposes the inconsistent ranking of projects by NPV and IRR. The Merseyside project has an NPV of £9.3 million, while the Rotterdam project has an NPV of £10.5 million. However, the Merseyside project has a higher IRR of 25%, while the Rotterdam project has an IRR of 20%. Since the two projects have different cash flow profiles and risk profiles, so they should be evaluated based on multiple criteria, including IRR, payback period, and sensitivity analysis.
Why don’t the various investment criteria rank the two projects identically?
The various investment criteria don’t rank the two projects identically because of the crossover problem, which is caused by the massive differences in the time profiles of cash flow. The Merseyside project has earlier cash flows, while the Rotterdam project has later cash flows. The IRR assumes that cash flows are reinvested at the same rate as the IRR, while the NPV assumes that cash flows are reinvested at the company’s cost of capital. The IRR method assumption may not be a reasonable assumption in practice, while the NPV method may provide a more reliable measure of project value.