16. The replacement chain approach Evaluating projects with unequal lives Aa Aa

Question

16. The replacement chain approach Evaluating projects with unequal lives Aa Aa Evaluating projects with unequal lives Your company is considering starting a new project in either Italy or Canada-these projects are mutually exclusive, so your boss has asked you to analyze the projects and then tell her which project will create more value for the company's stockholders The Italian project is a six-year project that is expected to produce the following cash flows: The Canadian project is only a three-year project; however, your company plans to repeat the project after three years. The Canadian project is expected to produce the following cash flows: Project: Year 0 -$700,000 Year 1 $240,000 Year 2: $270,000 Year 3 $290,000 Year 4: $250,000 Year 5: $130,000 Year 6 $110,000 Italian Project: Canadian Year 0: -$490,000 Year 1: $250,000 Year 2: $265,000 Year 3 $275,000 Because the projects have unequal lives, you have decided to use the replacement chain approach to evaluate them. You have determined that the appropriate cost of capital for both projects is 10%. 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 remains at 10%, fill out the following table NPV Italian project: NPV Canadian project:

Explanation / Answer

NPV is calculated by discounting the cashflows

PV = C/(1+r)^n

C - Cashflow

r - Discount rate

n - years to the cashflow

Italian project:

NPV = -700000 + 240000/(1+0.1)^1 + 270000/(1+0.1)^2 + 290000/(1+0.1)^3 + 250000/(1+0.1)^4 + 130000/(1+0.1)^5 + 110000/(1+0.1)^6 = $272768.87

Canadian project:

NPV = -490000 + 250000/(1+0.1)^1 + 265000/(1+0.1)^2 + 275000/(1+0.1)^3 + (-490000)/(1+0.1)^3 + 250000/(1+0.1)^4 + 265000/(1+0.1)^5 + 275000/(1+0.1)^6 = $285276.15

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