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 11%?

	Cash Flow
Project A
Year 0:	$12,500	Year 0:	$40,000
Year 1:	8,000	Year 1:	8,000
Year 2:	14,000	Year 2:	15,000
Year 3:	13,000	Year 3:	14,000
		Year 4:	13,000
		Year 5:	12,000
		Year 6:	11,000

$9,468

$15,780

$12,624

$11,835

$10,257

Smith and Co. is considering a three-year project that has a weighted average cost of capital of 10% and a NPV of $85,647. Smith and Co. can replicate this project indefinitely. What is the equivalent annual annuity (EAA) for this project?

$34,440

$37,884

$36,162

$29,274

$30,996

Attempts: Do No Harm: /2 3. Analysis of a replacement project At times firms will need to decide if they want to continue to use their current equipment or replace the equipment with newer equipment. The company will need to do replacement analysis to determine which option is the best financial decision for the company. Price Co. is considering replacing an existing piece of equipment. The project involves the following: The new equipment will have a cost of $2,400,000, and it will be depreciated on a straight-line basis over a period of six years (years 1-6). The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and four more years of depreciation left ($50,000 per year). The new equipment will have a salvage value of $0 at the end of the project's life (year 6). The old machine has a current salvage value (at year 0) of $300,000. Replacing the old machine will require an investment in net operating working capital (NOWC) of $45,000 that will be recovered at the end of the project's life (year 6). The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of $500,000 in each of the next six years (years 1-6). Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that earned using the old equipment. The project's cost of capital is 13%. The company's annual tax rate is 40%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Year 1 you Year 2 Year 3 Year 4 Year 5 Year o $2,400,000 Initial investment EBIT $500,000 $500,000 $500,000 $500,000 $500,000 - Taxes + New depreciation - Old depreciation + Salvage 300,000 value - Tax on salvage - NOWC 45000 - Recapture of NOWC $700,000 Total free cash flow - - - The net present value (NPV) of this replacement project is: O $583,411. $364,632 $486,176. $413,250