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Your firm has estimated the following cash flows for two mutually exclusive capital investment projects. The firm's required rate of return is 13%.
Year Project A Cash Flow Project B Cash Flow
0 -$100,000 -$100,000
1 28,900 48,000
2 28,900 40,000
3 28,900 40,000
4 28,900 5 28,900
Which of the following statements best describes projects A and B?
a) Project A should be accepted because it has the highest NPV.
b) Project A should be accepted because it has the highest EAA.
c) Project B should be accepted because it has the highest EAA.
d) Both projects should be accepted because they have positive NPVs and EAAs.
e) Neither project is acceptable.

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Respuesta :

Answer:

c) Project B should be accepted because it has the highest EAA.

Explanation:

EAA is the annuity payment that is equal to the value of the NPV

Net present value is the present value of after tax cash flows from an investment less the amount invested.  

NPV can be calculated using a financial calculator  

NPV for project A

Cash flow in year 0 = -$100,000

Cash flow each year from year 1 to 5 = $28,900

I = 13%

NPV = $1647.98

Please find attached the formula used i calculating EAA = $468.54

NPV for project B

Cash flow in year 0 = -$100,000

Cash flow in year 1 = $48,000

Cash flow in year 2 = $40,000

Cash flow in year 3 = $40,000

I = 13%

NPV = $1,525.75

EAA = $646.19

When comparing projects with unequal lives, choose the project with the higher EAA. This is project B. Only project B can be chosen because the projects are mutually exclusive.

To find the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.  

3. Press compute  

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Zviko

Answer:

c) Project B should be accepted because it has the highest EAA.

Explanation:

First determine the Net Present Value of Project A and Project B.

Using a Financial Calculator the Net Present Values will be

Project A

-$100,000     CFj

$28,900        CFj

$28,900        CFj

$28,900        CFj

$28,900        CFj

13%                 I/YR

Shift NPV    - $14,037.78

Project B

-$100,000     CFj

$48,000        CFj

$40,000        CFj

$40,000        CFj

$28,900        CFj

13%                 I/YR

Shift NPV      $19250.66

The only correct statement is that  Project B should be accepted because it has the highest EAA.

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