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)

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Business

Averi Fry

18 October, 11:13

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)

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Ortega · Answer 1

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