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

This preview shows page 1. Sign up to view the full content.

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
This is the end of the preview. Sign up to access the rest of the document.

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 project’s 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....
View Full Document

{[ snackBarMessage ]}

Ask a homework question - tutors are online