Comparisons between mutually exclusive alternatives require that adjustment be m

Question

Comparisons between mutually exclusive alternatives require that adjustment be made for the possibility that they have different economic lives. One way is to assume co-termination; the other is the assumption of repeatability. What are the assumptions of repeatability, and how reasonable are they likely to be? Give an example to illustrate your answer. [20%] Two years ago Ferguson Products bought a generator for 20,000 with an expected working life of 10 years at which time its salvage value would be zero. Recent experience has shown that its first year [end-year] operating costs were 3,000, increased by 0.07 in the second year, and promises to increase by 0.07 per annum for the rest of its working life. This generator is the Defender. Recently a new generator has come on the market, whose initial cost is expected to be 25,000, first year operating costs to be 2,500, but to decrease by 0.05 per annum. To allow a comparison with the Defender, an estimate of its salvage value at the end of 8 years is given, and expected to be 12,000. This generator is the Challenger. All the above financial data are expressed in constant prices, and Ferguson's Minimum Attractive Rate of Return [MARR=i_r] is 0.10 per annum. Flow large must the current Market Value of the Defender be to justify its replacement by the Challenger, on financial grounds? [30%]

Explanation / Answer

Repeatability means the ability of a project to start again. Hen two projects with unequal lives are compared, the project with shorter life is expected to restart after its expiration so that lives of the two projects can be equated and compared with each other.

For example, let’s assume there are two mutually exclusive projects. Project A has expected life of 10 years whereas project B has an expected life of 15 years. Since the projects has unequal life, we will assume that project A will be repeated after 10 years.

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