Allied Biscuit Co. has to choose between two mutually exclusive projects. If it

Question

Allied Biscuit Co. has to choose between two mutually exclusive projects. If it chooses project A, Allied Biscuit Co. will have the opportunity to make a similar investment in three years. However, if it chooses project B, it will not have the opportunity to make a second investment. The following table lists the cash flows for these projects. If the firm uses the replacement chain (common life) approach, what will be the difference between the net present value (NPV) of project A and project B, assuming that both projects have a weighted average cost of capital of 11%? Cash Flow Project A Project B

Explanation / Answer

NPV of project A

= -17500 + 10000/1.11 + 16000/1.11^2 + 15000/1.11^3 - 17500/1.11^3 + 10000/1.1^4 + 16000/1.11^5 + 15000/1.11^6

= $27011.95

NPV of project B

=

= -45000 + 9000/1.11 + 16000/1.11^2 + 15000/1.11^3 + 14000/1.1^4 + 13000/1.11^5 + 12000/1.11^6

= $10754.68

DIfference in NPV = 27011.95 - 10754.68 = $16,257.27

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