FM11 44 - project's cash flows are identical to the first...

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k. 3. Now apply the replacement chain approach to determine the projects’ extended NPVs. Which project should be chosen? Answer: The simple replacement chain approach assumes that the projects will be replicated out to a common life. Since project S has a 2-year life and L has a 4-year life, the shortest common life is 4 years. Project L's common life NPV is its raw NPV: Common Life NPV L = $6,190. However, project S would be replicated in year 2, and if we assume that the replicated
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Unformatted text preview: project's cash flows are identical to the first set of cash flows, then the replicated NPV is also $4,132, but it "comes in" in year 2. We can put project S's cash flow situation on a time line: 0 1 2 3 4 | | | | | 10% 4,132 4,312 3,415 7,547 Here we see that S's common life NPV is NPV S = $7,547. Thus, when compared over a 4-year common life, project s has the higher NPV, hence it should be chosen. Project s would have the higher NPV over any common life. Mini Case: 11 - 44...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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