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You are analyzing the Photon project, which has the expected cash flows below. The Photon project...

You are analyzing the Photon project, which has the expected cash flows below. The Photon project has a 4 year life (assume "best life") and is competing against another project for funding (the Warp project). That is, the two projects are mutually exclusive. The Warp project has an 8 year life (assume "best life"; cash flows not provided).

You notice that the projects have lives of different lengths, so you ask whether the Photon project can be repeated at the end of 4 years. The answer is that it can be. To adjust for the differing lives, you decide to use the NPV replacement chain method. For your initial analysis, you are to assume that Photon can be duplicated exactly.

Using the replacement chain method and a discount rate of 16.0%, compute Photon's NPV, in a way that would be appropriate to compare to the NPV of the Warp project. Round to nearest penny.

Year 0 cash flow = -171,000
Year 1 cash flow = 78,000
Year 2 cash flow = 78,000
Year 3 cash flow = 78,000
Year 4 cash flow = 78,000

Solutions

Expert Solution

Replacement chain method is used to compare mutually exclusive projects that have a different life span. Here the Photon project has a four-years life while the life of the Warp project is 8 years. So, we can replicate the photon project

Below are the cash flows resulting from the first and the replicated Photon project and the table also shows the total cash flows:

0 1 2 3 4 5 6 7 8
CF from 1st Photon project -171000 78000 78000 78000 78000
CF from replicated Photon project -171000 78000 78000 78000 78000
Total Cash flows -171000 78000 78000 78000 -93000 78000 78000 78000 78000

The present value of the cash flow Cn at the nth period is calculated using the below formula:

where r is the discount rate which is 16% in this example.

NPV is the present values of all the cash flows occurring in a project.

NPV = -171000+ 67241.38+ 57966.71+ 49971.3+ (-51363.1)+ 37136.82+ 27598.7+ 23791.99 = 73358.31

Now, this NPV Value can be compared with that of The warp project to decide which project has a greater NPV.


jeff jeffy answered 1 year ago
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