Question

TA is considering investing in one of the following two projects, where the chosen project will be replicated repeatedly in the future:

	Project X	Project Y
Initial investment	$100,000	$125,000
Life of project	3 years	4 years
Annual after-tax cash flows	Year 1: $45,000	Year 1: $47,000
	Year 2: $45,000	Year 2: $47,000
	Year 3: $70,000	Year 3: $47,000
		Year 4: $67,000
Required rate of return	10%	10%

Which project is most beneficial for TA, and what is its EAA?

(A.) Project X; EAA = $12,341

(B.) Project X; EAA = $30,691

(C.) Project Y; EAA = $11,876

(D.) Project Y; EAA = $37,644

(E.) Neither Project X nor Project Y

Answer 1

Equivalent Annual Annuity(EAA) is used to compare projects with unequal lives. EAA spreads the NPV of the project over the life of the project as an annuity.

So, to calculate EAA, we need to first calculate the NPV of the projects.

Formulas:

Now, we need to calculate PMT using excel to get the Annuity cash flow or using the formula

EAA= (r*NPV)/1-(1+r)^^-n

Calculation is as follows:

Formulas:

As the chosen project will be replicated repeatedly in the future, the project will a higher EAA should be chosen.

Therefore, the correct answer is (A.) Project X; EAA= $12,341