Your firm is considering two different projects that are mutually exclusiveand they will be replaced once the project is over. Given a required return of 12%, which project should your firm undertake(Hint: you should calculate the EAA to decide which is the better project for this problem)
Time 0 1 2 3
Project A -25,000 15,000 20,000 20,000
Project B -25,000 11,000 11,000 11,000
Answer:
Project A should be better and should be accepted because it produces a higher EAA of $7,732.5746
Explanation:
NPV = PV of cash inflow- Initial cost
PV of cash inflow = 15,000×1.12^(-1) + 20,000×1.12^(-2) + 20,000×1.12^(-3)=43,572.33
NPV = 43,572.33 -25,000 =18572.33965
EAA= NPV /Annuity factor
= 18572.339/2.401831268 = 7732.57468
Project B
PV of annuity = A× (1- (1+r)^(-n))/r
= 11,000× (1-1.12^(-4))/0.12=33410.84281
NPV = 33410.84281 - 25,000= 8410.842813
EAA = 8410.842/3.03734 =2769.139
Project A should be better and should be accepted because it produces a higher EAA of $7,732.5746
