Question

A project requires an investment of $1,200 today and it is expected to generate free cash flows of $400 at the end of year 1, $500 at the end of year 2 and, $700 at the end of year 3. The company's weighted average cost of capital is 10.4% per year. What is the project's equivalent annual annuity? 1) $19.7 2) $28.3 3) $37.6 4) $16.4 5) $33.9

Answer 1

Following is the fomula to calculate EAA
C = (r x NPV) / (1 - (1 + r)power -n )
Here
C	equivalent annuity cash flow
NPV	net present value
r	interest rate per period
n	number of periods
So we have to first calculated the NPV here
NPV of this project is as follows:
Year	Cash Flow	factor	Net (CF*Factor)
0	-1,200	1	-1,200.00
1	400	0.91	362.32
2	500	0.82	410.23
3	700	0.74	520.22
		NPV	92.78
So
NPV	92.78
r	0.104
n	3
Therefore the EAA is option 3 i.e. 37.6