Question

4. Unequal project lives Galaxy Corp. has to choose between two mutually exclusive projects. If it chooses project A, Galaxy Corp. will have the opportunity to make a similar investment in three years. However, if it chooses project B, it will not have the opportunity to make a second investment. The following table lists the cash flows for these projects. If the firm uses the replacement chain (common life) approach, what will be the difference between the net present value (NPV) of project A and project B, assuming that both projects have a weighted average cost of capital of 11%? Cash Flow Project A Year o: Year 1: Year 2: Year 3: -$12,500 8,000 14,000 13,000 Year 0: -$45,000 Year 1: 10,000 Year 2: 17,000 Year 3: 16,000 Year 4: 15,000 Year 5: 14,000 Year 6: 13,000 $13,551 $12,319 $7,391 $8,007 $11,087 Galaxy Corp. is considering a three-year project that has a weighted average cost of capital of 10% and a NPV of $45,681. Galaxy Corp. can replicate this project indefinitely. What is the equivalent annual annuity (EAA) for this project? $22,961 $18,369 $22,043 $16,532 $15,614

Answer 1

YEAR pv @ 11% Project A -$12,500 $8,000 $14,000 $500 $8,000 $14,000 $13,000 cash flows Project B -$45,000 $10,000 $17,000 $16,000 $15,000 $14,000 $13,000 NPV 1.0000 0.9009 0.8116 0.7312 0.6587 0.5935 0.5346 discounted cash flows Project A Project B -$12,500.00 -$45,000.00 $7,207.21 $9,009.01 $11,362.71 $13,797.58 $365.60 $11,699.06 $5,269.85 $9,880.96 $8,308.32 $8,308.32 $6,950.33 $6,950.33 $26,964.01 $14,645.27 Less: NPV of Project A= NPV of Project B = Difference between NPV $26,964 $14,645 $12,319 Equivalent annual annuity = $18,369 [ 45681 = PVIFA(10%, 3 Years) ]