27 spreadsheet use comparison of the net present

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Unformatted text preview: heir respective NPVs of $11,277.24 and $19,013.27. Spreadsheet Use Comparison of the net present values of two projects with unequal lives also can be calculated as shown on the following Excel spreadsheet. CHAPTER 10 Risk and Refinements in Capital Budgeting 443 Ignoring the differences in project lives, we can see that both projects are acceptable (both NPVs are greater than zero) and that project Y is preferred over project X. If the projects were independent and only one could be accepted, project Y—with the larger NPV—would be preferred. On the other hand, if the projects were mutually exclusive, their differing lives would have to be considered. Project Y provides 3 more years of service than project X. The analysis in the above example is incomplete if the projects are mutually exclusive (which will be our assumption throughout the remaining discussions). To compare these unequal-lived, mutually exclusive projects correctly, we must consider the differing lives in the analysis; an incorrect decision could result from simply using NPV to select the better project. Although a number of approaches are available for dealing with unequal lives, here we present the most efficient technique—the annualized net present value (ANPV) approach. Annualized Net Present Value (ANPV) Approach annualized net present value (ANPV) approach An approach to evaluating unequal-lived projects that converts the net present value of unequal-lived, mutually exclusive projects into an equivalent annual amount (in NPV terms). The annualized net present value (ANPV) approach converts the net present value of unequal-lived projects into an equivalent annual amount (in NPV terms) that can be used to select the best project.7 This net present value based approach can be applied to unequal-lived, mutually exclusive projects by using the following steps: Step 1 Calculate the net present value of each project j, NPVj, over its life, nj, using the appropriate cost of capital, k. 7. The theory underlying this as well as other approaches for comparing projects with unequal lives assumes that each project can be replaced in the future for the same initial investment and that each w...
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