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A company s considering a project which requires the initial outlay of $300,000 which includes both...

A company s considering a project which requires the initial outlay of $300,000 which includes both an after-tax salvage from the old asset of $12,000 and an additional working capital investment of $8,000. The 12-year project is expected to generate annual incremental cash flows of $54,000 and have an expected terminal value at the end of the project of $20,000. The cost of capital is 15 percent, and the company's marginal tax rate is 40 percent. Calculate the net present value of this project.

  • -$3,548.43
  • $68,781.83
  • -$6,544.56
  • -$596,451.57
  • $12,713.43

Sue is trying to determine which of two projects to undertake. Both projects have equal initial outlay. Project A has an NPV of $4,392.15, an IRR of 11.33%, and an EAA of $1,158.64. Project B has an NPV of $5,833.73, an IRR of 9.88%, and an EAA of $1,093.50. The cost of capital for both projects is 9%, the projects have different lives, and the projects are repeatable. What should Sue do?

  • You should do neither project because neither of them would add value to your company.
  • You should do Project Adam because it has a higher IRR.
  • You should do Project Adam because it has a higher EAA.
  • You should do both projects because both have positive NPVs.
  • You should do Project Eve because it has a higher NPV.
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Homework Answers

Answer #1

1. The cashflows are shown in the below table and for Year12 cashflow we should add salvage value of $20,000 becoming the total cashflow to $74,000

NPV has to be found by using NPV function in EXCEL

=NPV(rate, Year1 to Year12 cashflows)-Year0 cashflow

=NPV(15%,Year1 to Year12 cashflows)-300000

NPV=-$3548.43 (option a is correct)

Cost of capital 15%
Year0 -300000
Year1 54000
Year2 54000
Year3 54000
Year4 54000
Year5 54000
Year6 54000
Year7 54000
Year8 54000
Year9 54000
Year10 54000
Year11 54000
Year12 74000
NPV -3548.43

2. If the projects have different lives and projects are repeatable, Equivalent Annual Annuity (EAA) is the correct measure to accept or reject a project.

Project having higher EAA has to be selected, project Adam has to be selected because of higher EAA

Option C is correct

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