Question

Scenario: Sumaira has to choose between spending $25 on one umbrella that provides 5 years of...

  1. Scenario: Sumaira has to choose between spending $25 on one umbrella that provides 5 years of protection worth $10 per year in dry cleaning savings or a $5 umbrella that provides $9 of protection for one year.
  2. Calculate NPVs @ 7% with the replacement chain method and make a recommendation. Which umbrella should she buy? Hint: assume she would buy a new, $5 umbrella every year vs. a single $25 umbrella.
  3. Calculate Equivalent Annual Annuities @ 7% and make a recommendation. Which umbrella should she buy? Is your recommendation the same as with the Replacement Chain Method?
  4. Use Excel
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Answer #1

Excel formula for NPV = NPV(rate, select the cashflows)

With replacement NPV of the umbrella cost $25 is higher than $5 so it is recommended.

In the Equivalent Annual Annuities approach also the recommendation is the same as the $25 umbrella has higher NPV.

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