Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A

Question

Zellars, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Zellars, Inc.'s required rate of return for these projects is 10%. Which project would you recommend using the replacement chain method to evaluate the projects with different lives?Answer a. Project B because its NPV is higher than Project A's replacement chain NPV of $47,623.

Explanation / Answer

NPV of project A = -95000 + 65000/(1 + 0.1)^1 + 75000/(1+0.1)^2 = 26074.38

NPV of project B = -120000 + 64000/(1 + 0.1)^1+ 67000/(1 + 0.1)^2 +56000/(1 + 0.1)^3 + 45000/(1 + 0.1)^4

= 66362.95

We should recommend Project B because its NPV is higher than Project A's NPV

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