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Subject 4. NPV Profiles
#capital-budgeting #cfa #cfa-level-1 #corporate-finance #has-images
A NPV profile is a graph showing the relationship between a project's NPV and the firm's cost of capital. The point where a project's net present value profile crosses the horizontal axis indicates a project's internal rate of return.
Some observations:
- The IRR is the discount rate that sets the NPV to 0.
- The NPV profile declines as the discount rate increases.
- Project A has a higher NPV at low discount rates, while Project B has a higher NPV at high discount rates. The NPV profiles of Project A and B join at the crossover rate, at which the projects' NPVs are equal.
- The slope of Project A's NPV profile is steeper. This indicates that Project A's NPV is more sensitive to changes in the discount rates.
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