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However, if we make our decision based on the raw NPVs, we would be biasingthe decision against the shorter project.Since the projects are expected to bereplicated, if we initially choose project S, it would be repeated after 2 years.However, the raw NPVs do not reflect the replication cash flows.
Mini Case:10 - 16
j.2.Now apply the replacement chain approach to determine the projects’ extendedNPVs.Which project should be chosen?34||j.3.Now assume that the cost to replicate project S in 2 years will increase to$105,000 because of inflationary pressures.How should the analysis behandled now, and which project should be chosen?34||Mini Case:10 - 17
k.You are also considering another project which has a physical life of 3 years;that is, the machinery will be totally worn out after 3 years.However, if theproject were terminated prior to the end of 3 years, the machinery would havea positive salvage value.Here are the project’s estimated cash flows:Initial InvestmentEnd-Of-YearAnd OperatingNet SalvageYearCash FlowsValue_0($5,000)$5,00012,1003,10022,0002,00031,750Using the 10 percent cost of capital, what is the project’s NPV if it is operatedfor the full 3 years?Would the NPV change if the company planned toterminate the project at the end of year 2?At the end of year 1?What is theproject’s optimal (economic) life?03|2|