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Analysis of Replacement Project: Allied is thinking of replacing the old food processing machine with a new, highly efficient machine. Below is the cash flows if Allied continues using the old machine and if Allied replaces the old machine with the new machine. Please figure out the incremental CFs for this replacement project. If WACC is 10%, what is the NPV and IRR of this replacement project? Should you accept this project? 2 3 Replacement Project Period Part I. Free Cash Flows if continues using the old machine: Free cash flows: $1,000 $1,000 $1,000 $1,000 Part II. Free Cash Flows if replacing with the new machine: Free cash flows: $2,000 $1,500 $1,600 $1,700 $1,500 Part III. Incremental Cash Flows and Evaluation: Incremental CFs of Replacement Project: Project Evaluation @ WACC - 10% NPV = IRR = Should you accept this Replacement Project? Answer: Unequal Project Lives: Allied is analyzing two new machines that will upgrade its old machine for its health-food product, i.e. these two new machines are mutually exclusive. Machine A can be used for 6 years, and Machine B can be used for 3 years. The health-food product is very successful, so the machines will be repurchased at the end of each machine's useful life. In other words, the machines are "repeatable" projects. Below is the timeline for each machine. First, calculate the NPV for each machine according to the original timeline. What would be your choice between these two machines, according to this traditional analysis? Then, make adjustment for the unequal lives issues between these two machines. What would be your choice between these two machines, after adjusting for the unequal lives? Part I. Traditional Analysis WACC = 10% Machine A: Period Time Line: 34 $1,400 $1,600 ($5,000) $1,000 $1,200 $1,800 $2,000 NPVA Machine B: Years Time Line: ($3,500) $1,500 $1,500 $2,000 NPV = Your Choice according to traditional analysis, which is inappropriate in this situation: Part II. Replacement Chain Adjustment Machine A: Period Time Line: 0 ($5,000) $1,000 $1,200 $1,400 $1,600 $1,800 $2,000 NPVA Machine B: Time Line NPV, Your Choice: Photos Part III. Equivalent Annual Annuity (EAA) Method Machine A Machine B I/YR: FV: PMT=EAA: Your Choice