Globex Corp. has to choose between two mutually exclusive projects. If it choose

Question

Globex Corp. has to choose between two mutually exclusive projects. If it chooses project A, Globex Corp. 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 12%? $14,804 $13,982 $16,449 $13,159 $12,337 Globex Corp. is considering a five-year project that has a weighted average cost of capital of 14% and a NPV of $80,720. Globex Corp. can replicate this project indefinitely. What is the equivalent annual annuity (FAA) for this project? $27,039 $23,512 $25,863 $22,336 $19,985

Explanation / Answer

We have the following cash flows from project A:

Year

Cash flow

0

-20000

1

11000

2

17000

3

16000-20000

4

11000

5

17000

6

16000

We need to discount the difference of cash flows to calculate NPV:

Year

Project A

Project B

Difference

PV factor 12%

PV

0

-20000

-45000

25000

1.0000

25000

1

11000

9000

2000

0.8929

1785.714

2

17000

16000

1000

0.7972

797.1939

3

-4000

15000

-19000

0.7118

-13523.8

4

11000

14000

-3000

0.6355

-1906.55

5

17000

13000

4000

0.5674

2269.707

6

16000

12000

4000

0.5066

2026.524

16448.76

Hence . NPV would be 16,449.

Year

Cash flow

0

-20000

1

11000

2

17000

3

16000-20000

4

11000

5

17000

6

16000

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