A company wants to replace a machine with a modern, more efficient model with a

Question

A company wants to replace a machine with a modern, more efficient model with a longer life expectancy. The equipment requires an initial investment of $600,000 in Year 0. The expected cash flows and standard deviations are as follows:

Year Cash Flow Standard Deviation

1 $140,000 $15,000

2 $160,000 $ 50,000

3 $ 300,000 $ 100,000

4 $ 400,000 $ 120,000

The firm's WACC is 16% and the risk-free rate is 6%. The analyst develops the following CEFs.

Certainty Equivalent Factor (CEF)

Coefficient of Variation (CV) Year 1 Year 2 Year 3 Year 4

CV (less than or equal to) 0.30 .95 .92 .89 .85   

CV > 0.30 .85 .82 .78 .73

What are the project's NPV and its CE(NPV)?

Explanation / Answer

Solution ;

P
roect NPv calculation :

Year cash flow Discount 16% Present value 0 -600000.00 1.00 -600000.00 1 140000.00 0.86 120689.66 2 160000.00 0.74 118906.06 3 300000.00 0.64 192197.30 4 400000.00 0.55 220916.44 Net present value 52709.46

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