Question

1. A firm is starting a new project that will cost $200,000. It is projected to last 5 years and to generate cash flows of $50,000, $70,000, $90,000, $50,000 and $30,000 from Years 1 through 5 respectively. If the discount rate is 10%, what is the EAA of this project? Round to the nearest penny. Do not include any unit such as $, %, etc.

2. Use the following information to answer next three questions:

  IO                    PI        IRR                 LIFE

Project 1       $300,000        1.12     14.38%           15 years

Project 2       $150,000        1.08     13.32%           6 years

Project 3       $100,000        1.20     16.46%           3 years

Assume that the cost of capital is 12%.

If the firm has a maximum capital expenditures budget of $450,000, and if the projects are mutually exclusive, and repeatable, which project(s) should be accepted?

Projects 1, 2 and 3 Projects 1 and 3 Projects 2 and 3 Project 3 Project 1

Answer 1

1. EAA of Project = $6,252.64

Firstly calculate the NPV of the Project:

NPV can be calculated using NPV function in excel or calculator

CF0 = -200,000, CF1 = 50,000, CF2 = 70,000, CF3 = 90,000, CF4 = 50,000, CF5 = 30,000, I/Y = 10%

=> Compute NPV = $23,702.43

EAA can be calculated using PMT function in excel or calculator

N = 5, PV = 23,702.43, I/Y = 10%, FV = 0 => Compute PMT = $6,252.64

2. Project-3

If the projects are mutually exclusive, and repeatable then Project 3 should be accepted. It's IO of $100,000 satisfies the maximum capital expenditures budget of $450,000. It has higher PI and IRR compared to other projects and lowest life among all the projects.

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.