Question

Haley’s Crockett Designs Inc. is considering two mutually exclusive projects. Both projects require an initial investment of $11,000 and are typical average-risk projects for the firm. Project A has an expected life of 2 years with after-tax cash inflows of $8,000 and $10,000 at the end of Years 1 and 2, respectively. Project B has an expected life of 4 years with after-tax cash inflows of $8,000 at the end of each of the next 4 years. The firm’s WACC is 12%.

Assume that the projects can be repeated and that there are no anticipated changes in the cash flows. Use the replacement chain analysis to determine the NPV of the project selected. Do not round intermediate calculations. Round your answer to the nearest cent.

Since Project B 's extended NPV = $   , it should be selected over Project A with an NPV = $   .

Answer 1

Application of the replacement chain (lowest common life) approach involves replacing Project A at the end of it 2-year life with an identical project over years 3-4.This allows a direct comparison of both projects over their lowest common 4-year life.

Project A

NPV = -$11,000 + [$8,000/1.12] + [($10,000 - $11,000)/1.12²] + [$8,000/1.12³] + [$10,000/1.12⁴]

= -$11,000 + $7,142.86 - $797.19 + $5,694.24 + $6,355.18 = $7,395.09

Project B

NPV = -$11,000 + [$8,000{(1 - 1.12^-4) / 0.12}]

= -$11,000 + [$8,000 x 3.0373] = -$11,000 + $24,298.79 = $13,298.79

As such,based on the replacement chain analysis, Project B should be selected over Project A because it provides a higher NPV over the 4-year common-life period.