Question

You are given the following information about Project Y and Project Z. **Show Formulas Used in Excel**

Year	Project Y	Project Z
0	($225,000)	($225,000)
1	210,000	95,000
2	98,000	88,000
3	---	73,000
4	---	87,500

The projects provide a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have an 9% cost of capital.

a. What is each project’s initial NPV without replication? Which project will you choose?

b. What is the IRR of each project?

c. What is each project’s equivalent annual annuity? Which project will you choose?

d. Now apply the replacement chain approach to determine the shorter project’s extended NPV. Which project should be chosen?

e. Now assume that the cost to replicate Project Y in 2 years will increase to $290,000 because of inflationary pressures. How should the analysis be handled now, and which project should be chosen?

Answer 1

Project Y & Z

a),b) & c)

Formula's

Present Value = B5/(1+$D$2)^A5 ($ Symbol is used for Absolute reference)

NPV = SUM(C5:C7)

Project with Highest NPV will be selected,So Project Z will be selected.

b) Internal Rate of Return

Formula's

Project Y = IRR(B5:B7)

Project Z = IRR(D5:D9)

If IRR = Discount rate, NPV = 0

c) Equivalent Annual Annuity

Formula's

Project Y = PMT(D2,2,-C10,0) = 28505.98

Project Z = PMT(D2,4,-D10,0) = 16847.25

Project with highest Equivalent Annual annuity will be choosen (In this Case, Project Y)

d)

Project Y will be choosen beacause of high NPV.

e)

Project Z will be choosen.

Hope it may clear your problem and feel free to ask any doubts...