Capital Budgeting: Evaluating Projects with unequal lives Evaluating projects wi

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Capital Budgeting: Evaluating Projects with unequal lives

Evaluating projects with unequal lives Savory Seafood Inc. is a U.S. firm that wants to expand Its business Internationally. It Is considering potential projects in both Germany and Canada, and the German project Is expected to take six years, where as the Canadian project is expected to take only three years. However, the firm plans to repeat the Canadian project after three years. These projects are mutually exclusive, so Savory Seafood Inc.'s CFO plans to use the replacement chain approach to analyze both projects. The expected cash flows for both projects follow: If Savory Seafood Inc.'s cost of capital is 11%, what Is the NPV of the German project? $198,074 $210,453 $272,351 $247,592 Assuming that the Canadian project's cost and annual cash inflows do not change when the project is repeated in three years and that the cost of capital will remain at 11%, what Is the NPV of the Canadian project, using the replacement chain approach? $275,177 $235,866 $262,073 $248,969

Explanation / Answer

Part 1)

NPV is the difference between the present value of cash inflows and cash outflows. It can be calculated with the use of following formula:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Cost of Capital)^1 + Cash Flow Year 2/(1+Cost of Capital)^2 + Cash Flow Year 3/(1+Cost of Capital)^3 + Cash Flow Year 4/(1+Cost of Capital)^4 + Cash Flow Year 5/(1+Cost of Capital)^5 + Cash Flow Year 6/(1+Cost of Capital)^6

________

Using the values provided in the question, we get,

NPV (German Project) = -975,000 + 350,000/(1+11%)^1 + 370,000/(1+11%)^2 + 390,000/(1+11%)^3 + 320,000/(1+11%)^4 + 115,000/(1+11%)^5 + 80,000/(1+11%)^6 = $247,592 (which is Option D)

________

Part B)

We will have to adjust the life of Canadian Project to 6 years and since, the annual cash inflows donot change, we will have the following equation for NPV,

NPV (Canadian Project - Replacement Chain) = -490,000 + 250,000/(1+11%)^1 + 265,000/(1+11%)^2 + 275,000/(1+11%)^3 - [490,000/(1+11%)^3 + 250,000/(1+11%)^4 + 265,000/(1+11%)^5 + 275,000/(1+11%)^6] = $262,073 (which is Option C)

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