Question

Equivalent annual annuities

Another method to deal with the unequal life problem of projects is the equivalent annual annuity (EAA) method. In this method the annual cash flows under the alternative investments are converted into a constant cash flow stream whose NPV is equivalent to the NPV of the comparative project’s initial stream.

Consider the case of Cute Camel Lumber Company:

Cute Camel Lumber Company is considering a three-year project that has a weighted average cost of capital of 12% and a net present value (NPV) of $49,876. Cute Camel Lumber Company can replicate this project indefinitely.

What is the equivalent annual annuity (EAA) for this project?

$21,804

$22,843

$23,881

$20,766

An analyst will need to use the EAA approach to evaluate projects with unequal lives when the projects are ............ . (mutually exclusive, Independent)

Answer 1