The replacement chain approach - Evaluating projects with unequal lives

Evaluating projects with unequal lives

Your company is considering starting a new project in either Germany or Canadathese 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 German project is a six-year project that is expected to produce the following cash flows:

Project:	German
Year 0:	$650,000
Year 1:	$220,000
Year 2:	$240,000
Year 3:	$245,000
Year 4:	$270,000
Year 5:	$120,000
Year 6:	$100,000

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

Project:	Canadian
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 9%. Assuming that the Canadian 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 9%, answer the following questions:

The NPV of the German project is:

$258,320

$244,724

$271,916

$231,129

The NPV of the Canadian project is:

$372,770

$391,409

$410,047

$354,132