Chapter 12 Cash Flow Estimation and Risk Analysis
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12-14 UNEQUAL LIVES Overton Clothes Inc. is considering the replacement of its old, fully
depreciated knitting machine. Two new models are available: (a) Machine 171-3, which
has a cost of $171,000, a 3-year expected life, and after-tax cash flows (labor savings and
depreciation) of $85,000 per year, and (b) Machine 356-6, which has a cost of $356,000, a
6-year life, and after-tax cash flows of $102,400 per year. Assume that both projects can be
repeated. Knitting machine prices are not expected to rise because inflation will be offset
by cheaper components (microprocessors) used in the machines. Assume that Overton's
WACC is 13%. Using the replacement chain and EAA approaches, which model should be
selected? Why?
2-15 REPLACEMENT CHAIN Rini Airlines is considering two alternative planes. Plane A has
an expected life of 5 years, will cost $95 million, and will produce after-tax cash flows of
$35 million per year. Plane B has a life of 10 years, will cost $112 million, and will produce
after-tax cash flows of $25 million per year. Rini plans to serve the route for 10 years. The