Question

Expected Net Cash Flows

                                            Year                    Project T                               Project F

                                               0                      ($100,000)                            ($100,000)

                                               1                           75,000                                  40,000

                                               2                           65,000                                  42,000

                                               3                              —                                      44,000

                                               4                              —                                      46,000

The projects provide a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have a 12% cost of capital.

a.   What is each project’s initial NPV without replication?

b.   What is each project’s equivalent annual annuity?

c.   Suppose you replicate Project T so that it has the same life as Project F. Which project would you choose?

Please show all formulas in Excel if possible.

Answer 1

Statement showing NPV and Equvivalent cost

For project T

Year	Cash flow	PVIF @ 12%	Present value
0	-100000	1	-100000
1	75000	0.893	66964.29
2	65000	0.797	51817.60
Total			18781.89
PVIFA(12%,2)			1.690
Equivalent cost			11113.208

For project F

Year	Cash flow	PVIF @ 12%	Present value
0	-100000	1	-100000
1	40000	0.893	35714.29
2	42000	0.797	33482.14
3	44000	0.712	31318.33
4	46000	0.636	29233.83
Total			29748.59
PVIFA(12%,2)			3.037
Equivalent cost			9794.3

Thus answers

a) NPV - Project T - 18781.89$ and Project F - 29748.59$

b) Annualised revenue - Project T - 11113.21$ and Project F - 9794.3$

c) Project F should be choosen