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# 18 time disparity example time project a year cash

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Unformatted text preview: \$8,455 PI = 1.18 3. Mutually Exclusive Investments with Unequal Lives Unequal Suppose our firm is planning to Suppose expand and we have to select 1 of 2 machines. They differ in terms of economic life They economic and capacity. capacity How do we decide which machine to How select? select? The after-tax cash flows are: Year Machine 1 Machine 2 Machine Machine 0 (45,000) (45,000) (45,000) 1 20,000 12,000 20,000 2 20,000 12,000 20,000 3 20,000 12,000 20,000 4 12,000 12,000 5 12,000 12,000 6 12,000 12,000 Assume a required return of 14%. Step 1: Calculate NPV Step NPV1 = \$1,433 \$1,433 NPV2 = \$1,664 \$1,664 So, does this mean #2 is better? No! The two NPVs can’t be No! compared! compared! Step 2: Equivalent Annual Annuity (EAA) method Annuity If we assume that each project will be If replaced an infinite number of times in the replaced future, we can convert each NPV to an annuity. annuity The projects’ EAAs can be compared to The can determine which is the best project! determine EAA: Simply annualize the NPV over the project’s life. project’s EAA with your calculator: EAA Simply “spread the NPV over the life Simply of the project” Machine 1: PV = 1433, N = 3,...
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