Edgar Justin Monique Cost of equipment 30M 20M 20M Replacement frequency (years) 16 8 4 Pre-tax...

	Edgar	Justin	Monique
Cost of equipment	30M	20M	20M
Replacement frequency (years)	16	8	4
Pre-tax cash flows per year	4M	4M	8M
Salvage	20M	10M	0

Depreciation rate for all equipment is 0.2 and tax rate is 35%. Cost of capital is 8%

a. What is the NPV of each project Edgar, Justin , and Monique

b. Which project is the best to use? (Hint: Use equivalent annual annuity or replacement chain method to answer this question)

Solutions

Expert Solution

a. Follow the below steps to compute NPV.

1. Put down all the cashflows from years 0 till the replacement year .

2. Always put a minus sign for costs

3. Subtract the tax for each cashflow every year

4. Add the salvage value and the depreciated equipment value to last year cashflow.

In Excel , using NPV function , the NPV of the three projects are determined as :

NPV of Edgar = 6.674 Million

NPV of Justin = 10.285 Million

NPV of Monique = 11.336 Million

b . Equivalent Annual Annuity can be used as a parameter to determine the best project :

C = ( r* NPV) / (1-(1+r)^-n) where n is the replacement years and r is the cost of capital.

C for Justin = 0.75 Million

C for Edgar = 1.79 Million

C for Monique = 3.42 Million

Thus , we can conclude that Monique is the best project to use as C is highest for that project.

jeff jeffy answered 1 year ago

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