Your firm is considering two different projects that are mutually exclusiveand they will be replaced once the project is over. Given a required return of 12%, which project should your firm undertake (Hint: you should calculate the EAA to decide which is the better project for this problem)

Your firm is considering two different projects that are mutually exclusiveand they will be replaced once the project is over. Given a required return of 12%, which project should your firm undertake (Hint: you should calculate the EAA to decide which is the better project for this problem)

Time 0 1 2 3

Project A - 25,000 15,000 20,000 20,000

Project B - 25,000 11,000 11,000 11,000

Answer:

Project A should be better and should be accepted because it produces a higher EAA of $7,732.5746

Explanation:

NPV = PV of cash inflow - Initial cost

PV of cash inflow = 15,000*1.12^ (-1) + 20,000*1.12^ (-2) + 20,000*1.12^ (-3) = 43,572.33

NPV = 43,572.33 - 25,000 = 18572.33965

EAA = NPV / Annuity factor

= 18572.339/2.401831268 = 7732.57468

Project B

PV of annuity = A * (1 - (1+r) ^ (-n)) / r

= 11,000 * (1-1.12^ (-4)) / 0.12=33410.84281

NPV = 33410.84281 - 25,000 = 8410.842813

EAA = 8410.842/3.03734 = 2769.139

Project A should be better and should be accepted because it produces a higher EAA of $7,732.5746