Question

A project with a life of 12 has an initial fixed asset investment of $17,220, an initial NWC investment of $1,640, and an annual OCF of –$26,240. The fixed asset is fully depreciated over the life of the project and has no salvage value.

If the required return is 19 percent, what is the project's equivalent annual cost, or EAC?

A. -$11,636.36
B. $-31,800,88
C. $-28,772.22
D. $-25,743.57
E. $-30,286.55

Answer 1

The Equivalent Annual Cost (EAC) for the project is $-26,216.87. This answer is calculated by first finding the present value of all project costs and then converting that into an annuity given the project's life and the required rate of return. Notably, the EAC calculated does not match any of the options provided.

Step-by-step explanation:

To calculate the Equivalent Annual Cost (EAC) of the project, we need to take into account the initial fixed asset investment, the net working capital investment, the annual operating cash flow, and the required rate of return.

First, we'll find the Present Value (PV) of the project’s cash flows. Since the project has no salvage value and the OCF is consistently negative, we sum the initial cash outflows to get the total PV of the project costs:

PV = Initial fixed asset investment + Initial NWC investment + PV(OCF)
= $17,220 + $1,640 + ($26,240/0.19) (since the OCF is an annuity perpetuity)
= $17,220 + $1,640 + $138,105.26
= $156,965.26

Next, we calculate the EAC which is the annuity payment that has the same PV as the project costs over the project's life. We use the formula for annuities:

EAC = PV / [(1 - (1 + r)^(-n)) / r]
= $156,965.26 / [(1 - (1 + 0.19)^(-12)) / 0.19]
= $156,965.26 / 5.9847
= $$-26,216.87

$-26,216.87, therefore, the correct answer isn't listed among the options provided in the question.