Question

A firm needs to estimate the equivalent annual annuity (EAA) of two projects, since these projects can be repeated indefinitely. Project X requires an intial investment of 31,000 today and is expected to generate annual cash flows of 11,000 for the next 21 years. Project Y requires an intial investment of 120,000 and is expected to generate monthly cash flows of 1,800 for the next 15 years. The cost of capital is 10%. The ____ has the highest EAA, which is ____.    A.) Project Y ; 6,245 B.) Project Y ; 7,416 C.) Project X; 6,620 D.) Project X; 7,416 E.) Project X; 7,786

Answer 1

First calculate NPV of X

N = 21, FV = 0, PMT = 11,000, rate = 10%

Use PV function in Excel

present value of inflow = 95,135.64

NPV = 95,135.64 - 31,000 = 64,135.54

nw calculate EAA

PV = 64,135.54, FV = 0, N = 21, rate = 10%

Use PMT function in Excel

EAA of X = 7416

First calculate NPV of Y

N = 180, FV = 0, PMT = 1800, rate = 10%/12

Use PV function in Excel

present value of inflow = 167,503.39

NPV = 167,503.39 - 120,000 = 47,503.39

nw calculate EAA

PV = 47,503.39, FV = 0, N = 15, rate = 10%

Use PMT function in Excel

EAA of Y = 6245

Answer: D.) Project X; 7,416