Question

4) The company you work for is trying to decide between two projects. Project 1 costs $160,000 up front, and has an expected life of 4 years, over which it will return $52,000 each of the four years. Project 2 would last for 20 years, costs $1.5 million up front, and returns $170,000 at the end of each of the 20 years. Assuming a real discount rate of 6%, which project has the higher equivalent annual net benefit?

Answer 1

Project 1:
Step-1:Calculate annual cost
annual cost		=	Initial cost/cumulative discount factor
		=	$       1,60,000	/	3.465
		=	$           46,175
Cumulative discount factor			=	(1-(1+i)^-n)/i			Where,
			=	(1-(1+0.06)^-4)/0.06			i	6%
			=	3.465			n	4
Step-2:Calculate equivalent annual net benefit
Annual return			$           52,000
Annual costs			$         -46,175
Equivalent annual net Benefit			$             5,825
Project 2:
step-1:Calculate annual cost
annual cost		=	Initial cost/cumulative discount factor
		=	$     15,00,000	/	11.46992
		=	$       1,30,777
Cumulative discount factor			=	(1-(1+i)^-n)/i			Where,
			=	(1-(1+0.06)^-20)/0.06			i	6%
			=	11.46992			n	20
Step-2:Calculate equivalent annual net benefit
Annual return			$       1,70,000
Annual costs			$     -1,30,777
Equivalent annual net Benefit			$           39,223
Thus, equivalent annual net benefit of are as follows:
Project 1			$             5,825
Project 2			$           39,223
Thus, Project 2 has higher equivalent annual net benefit.