Question

Wizard Inc. has to choose between two mutually exclusive projects. If it chooses project A, Wizard Inc. will have the opportunity to make a similar investment in three years. However, if it chooses project B, it will not have the opportunity to make a second investment. The following table lists the cash flows for these projects. If the firm uses the replacement chain (common life) approach, what will be the difference between the net present value (NPV) of project A and project B, assuming that both projects have a weighted average cost of capital of 11%?

	Cash Flow
Project A
Year 0:	–$15,000	Year 0:	–$45,000
Year 1:	9,000	Year 1:	9,000
Year 2:	15,000	Year 2:	16,000
Year 3:	14,000	Year 3:	15,000
		Year 4:	14,000
		Year 5:	13,000
		Year 6:	12,000

A. $18,097

B. $14,807

C. $9,871

D.$16,452

E. $11,516

Wizard Inc. is considering a five-year project that has a weighted average cost of capital of 14% and a NPV of $80,720. Wizard Inc. can replicate this project indefinitely. What is the equivalent annual annuity (EAA) for this project?

A. $22,336

B. $19,985

C. $29,390

D. $28,214

E. $23,512

Answer 1

1]	Project A		PVIF at 11%	PV of cash flows at 11%	Project B		PVIF at 11%	PV of cash flows at 11%
	Year 0:	$ 15,000	1	$ -15,000	Year 0:	$ -45,000	1	$    -45,000
	Year 1:	$ 9,000	0.90090	$            8,108	Year 1:	$ 9,000	0.90090	$ 8,108
	Year 2:	$ 15,000	0.81162	$ 12,174	Year 2:	$ 16,000	0.81162	$     12,986
	Year 3:	$ -1,000	0.73119	$ -731	Year 3:	$ 15,000	0.73119	$     10,968
	Year 4:	$ 9,000	0.65873	$            5,929	Year 4:	$ 14,000	0.65873	$ 9,222
	Year 5:	$ 5,000	0.59345	$            8,902	Year 5:	$ 13,000	0.59345	$ 7,715
	Year 6:	$ 14,000	0.53464	$            7,485	Year 6:	$ 12,000	0.53464	$ 6,416
	NPV			$ 26,867				$     10,415
	Difference in NPV [A-B] = 28867-10415 =			$ 16,452
	Answer: Option [D] $16,452
2]	EAA = 80720*0.14*1.14^5/(1.14^5-1) =			$ 23,512
	Answer: Option [E] $23,512