Question

e accepted Two projects with different planning horizons are difficult to compare. On technique is to compute the annualized worth of each and compare them directly in spite of the fact that they have different planning horizons. 4. Project A has a planning horizon of 20 years. 1-6%. Initial Cost is 500,000. Salvage Value decreases 10,00 per year each year. Revenue is 70,00 per year (net), Project B. has a planning horizon of 10 years. I-696. Initial Cost is 200,000. Revenue is 630,000 per year (net). Salvage Value is assumed to be o. Analyze the situation using Annualized Worth and ignore the difference is planning horizons

Answer 1

Project A:

Initial cost = 500,000

Salvage value at the end of the year 20: 500,000 – (20*1000)

                                                                      = 500,000 – 20,000

                                                                      = 480,000

Net Revenue: 70,00

Interest: 6%

Time Period: 20 years

Computation of NPV and annualized worth

1. Initial outflow: 500,000
2. Net cash flow: 7000 per year
3. Terminal Cash inflow (salvage value at the end of the project) : 480,000

Year	cash flow		Present value factor			Present value of cash flow
0	-500000		1			-500000
1 to 20	7000		11.47			80290
20	480000		0.312			149760
			Net Present Value			269950
			Present value annuity factor			11.47
			Annualised worth			23535.31

Therefore,, the annualised worth of project A is 23535.31.

Project B:

Initial cost = 200,000

Salvage value at the end of the year 10: 0

Net Revenue: 630000

Interest: 6%

Time Period: 10 years

Computation of NPV and annualized worth

1. Initial outflow: 200,000
2. Annual cash flow during the term of the project: 630,000
3. Terminal Cash inflow (salvage value at the end of the project) :

Year	cash flow		Present value factor			Present value of cash flow
0	-200000		1			-200000
1 to 10	630000		7.36			46,36,800
10	0		0			0
			Net Present Value			4436800
			Present value annuity factor			7.36
			Annualised worth			602826.1

Therefore the annualised worth of project b is 602826.1.

By comparing the annualised worth of project A and B, we find that the Project B is better than Project A. Hence, project B should be choosen.