FM11 43 - the decision against the shorter project. Since...

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Mini Case: 11 - 43 k. In an unrelated analysis, you have the opportunity to choose between the following two mutually exclusive projects: Expected Net Cash Flows Year Project S Project L 0 ($100,000) ($100,000) 1 60,000 33,500 2 60,000 33,500 3 -- 33,500 4 -- 33,500 The projects provide a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have a 10 percent cost of capital. k. 1. What is each project's initial NPV without replication? Answer: The NPVs, found with a financial calculator, are calculated as follows: Input the following: CF 0 = -100000, CF 1 = 60000, N J = 2, AND I = 10 to solve for NPV S = $4,132.23 $4,132. Input the following: CF 0 = -100000, CF 1 = 33500, N J = 4, AND I = 10 to solve for NPV L = $6,190.49 $6,190. However, if we make our decision based on the raw NPVs, we would be biasing
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Unformatted text preview: the decision against the shorter project. Since the projects are expected to be replicated, if we initially choose project S, it would be repeated after 2 years. However, the raw NPVs do not reflect the replication cash flows. k. 2. What is each projects equivalent annual annuity? Answer: We begin with the NPVs found in the previous step. We then find the annuity payment stream that has the same present value as follows: For Project S, input the following: N = 2, I/YR = 10, PV = 4,132.23, FV = 0, and solve for PMT = EAA = $2,380.95. For Project L, input the following: N = 4, I/YR = 10, PV = 6,190.49, FV = 0, and solve for PMT = EAA = $1,952.92. Project S is preferred because it has a higher EAA....
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