Question

1. Farmer Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and repeatable.

Year                           0                1                2                3                4

CF_S                          -$900         $800          $600                 

CF_L                          -$700         $300          $200          $400          $200

WACC: 10%

Given the two projects are of different length and both are repeatable, one suggestion is to use the replacement chain approach in evaluation. If this approach is used, which project will you choose? Show the calculations and explain your decision

Answer 1

Replacement Chain Method: In the replacement chain method, the cash flows projections for the projects under consideration are repeated up to the least common useful life. In our case Project S will be repeared twice.

Solutiuon given below:

Project CFS will be selected as the NPV for Project CFS is higher than Project CFL.