Question

# Your firm is considering two projects. Your boss asked you to use the Equivalent Annual Annuity...

Your firm is considering two projects. Your boss asked you to use the Equivalent Annual Annuity method. Project A has an expected life of seven years, will cost \$50,000,000, and will produce net cash flows of \$12,000,000 each year. Project B has a life of fourteen years, will cost \$60,000,000, and will produce net cash flows of \$10,000,000 each year. The firm’s cost of capital is 12%. What is the equivalent annual annuity for each project? Which project should the firm accept? Show your full work.

CAN YOU SHOW STEPS

NPV = Present value of cash inflows - Presnet value of cash outflows

Equivalent Annual Annuity = NPV/Present value Annuity factor

Project A, NPV = -50,000,000 + 12,000,000*PVAF(12%, 7 years)

= -50,000,000 + 12,000,000*4.5638

= \$4,765,600

EAA = 4,756,600/4.5638 = \$1,044,217.54

Project B. NPV = -60,000,000 +10,000,000*PVAF(12%, 14 years)

= -60,000,000 + 10,000,000*6.6282

= \$6,282,000

EAA = 6,282,000/6.6282

= \$947,768.62

Hence, project A is better since higher EAA