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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)

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 2 years ago

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