Question

14) A firm needs to estimate the equivilent annual annuity (EAA) of two projects, since these projects can be repeated indefinitely. Project X requires an initial investment of $41,000 today and is expected to generate annual cash flows of $12,000 for the next 26 years. Project Y requires an initial investment of $200,000 and is expected to generate monthly cash flows of $2,900 for the next 13 years. The cost of capital is 7%. The _____ has the highest EAA, which is _____.

A) porject Y; $11,546

B) Project Y; $12,239

C) Project Y; $9,301

D) Project X; $11,546

E) Project X; $8,533

Answer 1

Project X:

Present value of cash flow = PVA 7%,26 *CF

        = 11.82578*12000

            = 141909.36

NPV =present value -initial cost

          141909.36 -41000=100909.36

EAA = NPV /PVA 7%,26

          100909.36 / 11.82578

       = $ 8533

Project Y

monthly rate = 7/12=.58333%

number of months = 13 *12= 156

Present value =PVA .58333% ,156 *CF

       =102.24197*2900

          =296501.7

NPV = 296501.7 -200000 = 96501.7

EAA = 96501.7 / 102.24197

       = 943.86

CORRECT OPTION IS "E" PROJECT X , 8533