4. Unequal project lives Newtown Corp. has to choose between two mutually exclus

Question

4. Unequal project lives Newtown Corp. has to choose between two mutually exclusive projects. If it chooses project A, Newtown 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 13%? Cash Flow ProjectA Project B Year 0: Year 1: Year 2: Year 3: -$17,500 $10,000 $16,000 $15,000 Year 0: Year 1: Year 2: Year 3: Year 4 Year 5 Year 6: -$45,000 $10,000 $17,000 $16,000 $15,000 $14,000 $13,000 11,588 O $8,369 $14,163 O $12,875 O $7,725 Newtown Corp. is considering a four-year project that has a weighted average cost of capital of 12% and a NPV of $29,567. Newtown Corp. can replicate this project indefinitely. What is the equivalent annual annuity (EAA) for this project? O $9,247 O $8,274 9,734 $12,168 O $10,707

Explanation / Answer

For Project A, in year 3, net cash flow = 15,000 - 17,500 = -2,500 after which the cash flows are repeated.

NPV can be calculated using NPV function on a calculator or excel with 13% rate of return

Difference = 24,169 - 11,294 = $12,875.

Another way of doing it is taking the difference in cash flows for both projects and computing its NPV.

2) EAA can be calculated using PMT function

N = 4, I/Y = 12%, PV = 29,567, FV = 0 => Compute PMT = $9,734

A B -17500 -45000 10000 10000 16000 17000 -2500 16000 10000 15000 16000 14000 15000 13000 $24,169 $11,294

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