Question

**4. Unequal project lives**

Smith and Co. has to choose between two mutually exclusive projects. If it chooses project A, Smith and Co. 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 14%?

Cash Flow |
|||
---|---|---|---|

Project A | |||

Year 0: | –$10,000 | Year 0: | –$45,000 |

Year 1: | 7,000 | Year 1: | 10,000 |

Year 2: | 15,000 | Year 2: | 17,000 |

Year 3: | 14000 | Year 3: | 16,000 |

Year 4: | 15,000 | ||

Year 5: | 14,000 | ||

Year 6: | 13,000 |

$15,175

$14,227

$13,278

$16,124

$18,969

Smith and Co. is considering a four-year project that has a weighted average cost of capital of 12% and a NPV of $29,567. Smith and Co. can replicate this project indefinitely. What is the equivalent annual annuity (EAA) for this project?

$10,221

$9,247

$10,707

$9,734

$11,194

Answer #1

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