Question

Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,500 at the end of Years 1 and 2, respectively. Project Y has an expected life of 4 years with after-tax cash inflows of $4,600 at the end of each of the next 4 years. Each project has a WACC of 11%. What is the equivalent annual annuity of the most profitable project?

Answer 1

Answer:

Explanation:

First, find the NPV of each project.

Using a financial calculator with "CF" function, input the following;

Project X

Initial investment; CF0 = -10,000

Yr1 cashflow; CF1 = 6,000

Yr2 cashflow; CF2 = 8,500

Interest rate; I/Y = 11%

then CPT NPV = 2,304.20

Project Y

Initial investment; CF0 = -10,000

Yr1 cashflow; CF1 = 4,600

Yr2 cashflow; CF2 = 4,600

Yr3 cashflow; CF3 = 4,600

Yr4 cashflow; CF4 = 4,600

Interest rate; I/Y = 11%

then CPT NPV = 4,271.25

Next, calculate equivalent annual annuity of each project;

Project X;

Present value; PV = -2,304.20

Total duration; N = 2

Interest rate per year; I/Y = 11%

Onetime future cashflow; FV = 0

then CPT PMT = 1,345.50

Project Y;

Present value; PV = -4,271.25

Total duration; N = 4

Interest rate per year; I/Y = 11%

Onetime future cashflow; FV = 0

then CPT PMT = 1,376.74

Therefore, equivalent annual annuity  of most profitable project is $1,376.74