1. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -1  The Investment Timing Decision ◦ Sometimes you have the ability to defer an investment and select a time that is more ideal at which to make the investment decision ◦ The decision rule is to choose the investment date that results in the highest NPV today  Example: ◦ You can buy a computer system today for $50,000. Based on the savings it provides to you, the NPV of this investment ~ $20,000 ◦ However, you know that these systems are dropping in price every year ◦ When should you purchase the computer? LO4

2. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -2 Decision rule for investment timing: Choose the investment date which results in the highest NPV today LO4

3. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -3  Long-Lived vs. Short-Lived Equipment ◦ Suppose you must choose between buying two machines with different lives.  Machines D and E are designed differently, but have identical capacity and do the same job.  Machine D costs $15,000 and lasts 3 years. It costs $4,000 per year to operate.  Machine E costs $10,000 and lasts 2 years. It costs $6,000 per year to operate. ◦ Which machine should the firm acquire? LO4

4. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -4 Cash Costs [outflows] in Dollars Project:C 0 C 1 C 2 C 3 PV @ 6% Machine D15444$25.69 Machine E1066-$21.00 We cannot compare the PV of costs of assets with different lives LO4

5. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -5  For comparing assets with different lives, we need to compare their Equivalent Annual Costs  The Equivalent Annual Cost is the cost per period with the same PV as the cost of the machine LO4

6. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -6  An example of calculating equivalent annual cost Cash Flows in Dollars Project:C 0 C 1 C 2 C 3 PV @ 6% Machine D15444$25.69 Equivalent Annual cost:???$25.69 The equivalent annual cost is calculated as follows: Equivalent Annual Cost= PV of Costs / Annuity Factor = $25.69 / 3 Year Annuity Factor = $25.69 / 2.673 = $9.61 per year LO4

7. © 2012 McGraw-Hill Ryerson LimitedChapter 8 -7  If mutually exclusive projects have unequal lives, then you should calculate the equivalent annual cost of the projects  Picking the lowest EAC allows you to select the project which will maximize the value of the firm Cash Flows in Dollars Project:PV @ 6% Equivalent Annual Cost D $25.69$9.61 E $21.00$11.45 LO4

8.  Replacing an old machine ◦ You are operating an old machine that will last two more years before it gives up the ghost. ◦ It costs $12,000 per year to operate. ◦ You can replace it now with a new machine, which costs $25,000 but is much more efficient ($8,000 per year in operating costs) and will last for five years. ◦ Should you replace it now or wait a year? ◦ The opportunity cost of capital is 6 percent. © 2012 McGraw-Hill Ryerson LimitedChapter 8 - 8 LO4

9. Costs, $000s Year: 0 1 2 3 4 5 PV at 6% New machine - 25 8 8 8 8 8 58.70 Equivalent 5-year annuity 13.93 13.93 13.93 13.93 13.9358.70  Cash flow will be $13,930 for new machine  Cash flow will be $12,000 for old machine  Why replace an old machine with a new one that will cost $1930 more to run?  Wait the two years © 2012 McGraw-Hill Ryerson LimitedChapter 8 - 9 LO4