a. If the projects are independent and not repeatable, which project or projects should the company accept?
b. If the projects are mutually exclusive but not repeatable, which project should the
company accept?
c. Assume the projects are mutually exclusive and can be repeated indefinitely.
(1) Use the replacement chain method to determine the NPV of the project selected.
(2) Use the equivalent annual annuity method to determine the annuity of the
project selected.
d. Could a replacement chain analysis be modified for use where the project’s cash
flows are different each time it is repeated? Explain.
QUESTIONS
13-1 Explain in general terms what each of the following real options is and how it could
change projects’ NPVs, relative to what would have been estimated if the options were
not considered, and their corresponding risk.
a. Abandonment.
b. Timing.
c. Growth.
d Flexibility.
13-2 Would a failure to recognize growth options cause a firm’s actual capital budget to be
above or below the optimal level? Would your answer be the same for abandonment,
timing, and flexibility options? Explain.
13-3 Companies often have to increase their investment costs to obtain real options. Why
might this be so, and how could a firm decide if it was worth the cost to obtain a given
real option?
13-4 What’s a “replacement chain?” When and how are replacement chains used in capital
budgeting?
13-5 What’s an “equivalent annual annuity (EAA)?” When and how are EAAs used in capital
budgeting?
13-6 Suppose a firm is considering two mutually exclusive projects. One has a life of 6 years
and the other a life of 10 years. Both projects can be repeated at the end of their lives.
Might the failure to employ a replacement chain or EAA analysis bias the decision
toward one of the projects? If so, which one, and why?
13-7 How might the corporate WACC be affected by the size of a firm’s capital budget?
13-8 What is capital rationing
