13. The replacement chain approach - Evaluating projects with unequal lives

Evaluating projects with unequal lives

Your company is considering starting a new project in either Spain or Mexicothese projects are mutually exclusive, so your boss has asked you to analyze the projects and then tell her which project will create more value for the companys stockholders.

The Spanish project is a six-year project that is expected to produce the following cash flows:

Project:	Spanish
Year 0:	$800,000
Year 1:	$380,000
Year 2:	$400,000
Year 3:	$420,000
Year 4:	$375,000
Year 5:	$110,000
Year 6:	$85,000

The Mexican project is only a three-year project; however, your company plans to repeat the project after three years. The Mexican project is expected to produce the following cash flows:

Project:	Mexican
Year 0:	$530,000
Year 1:	$280,000
Year 2:	$290,000
Year 3:	$310,000

Because the projects have unequal lives, you have decided to use the replacement chain approach to evaluate them. You have determined that the appropriate cost of capital for both projects is 13%. Assuming that the Mexican projects cost and annual cash inflows do not change when the project is repeated in three years and that the cost of capital remains at 13%, answer the following questions:

The NPV of the Spanish project is:

$518,263

$494,705

$471,148

$447,591

The NPV of the Mexican project is:

$311,026

$270,457

$297,503

$324,548