8/2/2019 TCDN Group 3 (Project Interactions)
1/34
Corporate Finance
Group 3
Nguyn Th Phng Hoa
Nguyn Th Mai LinhThn Th Hng Hnh
Nguyn Th QuL Th Vn
8/2/2019 TCDN Group 3 (Project Interactions)
2/34
Some Special Cases in Valuing
Projects
8/2/2019 TCDN Group 3 (Project Interactions)
3/34
Mutually Exclusive Projects
Projects A & B to be mutually exclusive:Projects A & B to be mutually exclusive:You can only acceptYou can only accept project A or project Bproject A or project B but you can notbut you can not
accept both of themaccept both of them..
Or
Apartment
Cinema
8/2/2019 TCDN Group 3 (Project Interactions)
4/34
Cash Flow at
Beginning of Class
Cash Flow at End of
Class (150 mins later)
opportunity 1 -$1 $1.50
opportunity 2 -$10 $11.00
Mutually Exclusive Projects
Which would you choose?
Opportunity 1 or Opportunity 2?
8/2/2019 TCDN Group 3 (Project Interactions)
5/34
Mutually Exclusive Projects
Cash Flow at
Beginning of Class
Cash Flow at End
of Class (150
mins later) NPV IRR
opportunity 1 -$1 $1.50 $0.50 50%
opportunity 2 -$10 $11.00 $1.00 10%
Now,Which would you choose? The reason?
Based on IRR orN
PV?
The answer is to choose Opportunity 2,based onNPV!
8/2/2019 TCDN Group 3 (Project Interactions)
6/34
The IRR rule seems to indicate that if you have
to choose, you should go for opportunity 1 since
it has the higher IRR. If you follow IRR rule,
you make the wrong choice.
Mutually Exclusive Projects
The problem with IRR is thatit ignores the issues of Scale.
8/2/2019 TCDN Group 3 (Project Interactions)
7/34
When you need to choose between
mutually exclusive projects, the decision
rule is to calculate the NPV of each project
and, from that have a positive NPV,
choose the one whose NPV is highest.
Mutually Exclusive Projects
8/2/2019 TCDN Group 3 (Project Interactions)
8/34
The choice
Should the company save money today by installingCheaper machines that will not last as long?
Should the company save money today by installingCheaper machines that will not last as long?
Long-livedequipment
Short-livedequipment
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
9/34
Example 1: Choose between machine Aand machine B
lasts 3 yearsM
ach
ine A
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
10/34
lasts 2 yearsMachine B
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
11/34
Costs, Thousands of Dollars
( the cost of capital is 6%)
Year 0 1 2 3
Machine A 15 4 4 4
Machine B 10 6 6 -
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
12/34
Because the two machines produce exactly the sameproduct, but with unequal lives the only way to choosebetween them is on the basic ofequivalent annualcost, not on present value of costs.
PV of cost
- Equivalent annual cost (EAC) =
annuity factor
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
13/34
Annuity Factor
1 1
Annuity Factor = -
r r (1+r)t
* r: Discount rate
* t: Number of periods
8/2/2019 TCDN Group 3 (Project Interactions)
14/34
Machine A
4,000 4,000 4,000
- PV of cost = 15,000 + + +
(1+0.06) (1+0.06)2 (1+0.06)3
= 25,690
1 1
- Annuity factor = - = 2.673
0.06 0.06x(1+0.06)3
EAC = 25,690/2.673 = 9.61
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
15/34
Machine B
6,000 6,000
- PV of cost = 10,000 + + = 21,000
(1+0.06) (1+0.06)2
1 1
- Annuity factor = - = 1.8334
0.06 0.06x(1+0.06)2
EAC = 21,000 / 1.8334 = 11,450
Long versus Short-lived Equipment
8/2/2019 TCDN Group 3 (Project Interactions)
16/34
EAC ($11,450)EAC ($9,610)
Machine BMachine A
M
ach
ine A is better, because its EAC is less
Vs.
PV of cost ($21,000)PV of cost ($25,690) >
Choose to use the old one.
8/2/2019 TCDN Group 3 (Project Interactions)
27/34
Should you replace the old machine?
Old New
r = 10%
Last 4 years
operating cost: $7,000/year
Cost: $12,000
r = 10%
Last 2 more years
Operating cost: $11,000/year
8/2/2019 TCDN Group 3 (Project Interactions)
28/34
=> You should buy a new machineto replace the old one
Year 0 1 2 3 4 PV at
10%
New machine 12 7 7 7 7 34.19
Equivalent 4-year annuity
--- 10.78 10.78 10.78 10.78 34.19
8/2/2019 TCDN Group 3 (Project Interactions)
29/34
And now..For the best answer:
_The modestMercedes_cost of$99,000
& specially, a 5-day tour to Hawaii!
8/2/2019 TCDN Group 3 (Project Interactions)
30/34
Workshop 1: Machines F, G are mutually exclusive&have following investment and operating costs:
(Dollars)
Discount rate of10% Which is equivalent annual cost of each investment?
Which one do you choose?
Year
Machine
0 1 2 3
F 10,000 1,100 1,331
G 12,000 1,100 1,331 1,331
8/2/2019 TCDN Group 3 (Project Interactions)
31/34
* Machine F:
PV of costs = 10,000 +1,100
(1+0.1)+
1,331
(1+0.1)2= 12,100
Annuity factor =1
0.1-
1
0.1(1+0.1)2= 1.7355
-> EACF =12,100
1.7355= 6,972
SOLUTION
8/2/2019 TCDN Group 3 (Project Interactions)
32/34
* Machine G:
PV of costs = 12,000 +1,100
(1+0.1)+
1,331(1+0.1)2
+
1,331
(1+0.1)3= 15,100
Annuity factor =
1
0.1 -
1
0.1(1+0.1)3 = 2.4869
-> EACG=15,1002.4869
= 6,072
SOLUTION
8/2/2019 TCDN Group 3 (Project Interactions)
33/34
EACG Machine G is the better buy.
8/2/2019 TCDN Group 3 (Project Interactions)
34/34
Group 3
Top Related