Question

Giant Equipment Ltd. is considering two projects to invest next year. Both projects have the same

start-up costs. Project A will produce annual cash flows of $42,000 at the
beginning of each year for
eight years. Project B will produce cash flows of $48,000 at the end of each year for seven years. The
company requires a 12% return.
Required:
a)Which project should the company select and why?
b)Which project should the
company select if the interest rate is 14% at the cash flows in Project B
is also at the beginning of each year?

Answer 1

Step-by-step explanation:

Given that :

Project A will produce annual cash flows of $42,000 at the beginning of each year for eight years.

Project B will produce cash flows of $48,000 at the end of each year for seven years.

Return rate = 12% = 0.12

a) Which project should the company select and why?

To determine the project which the company should select; let find the PV of cash flow:

For project A; PV of cash flows at the beginning of the each year is determined with the use of the expression:

`PV = (PMT)/(i) [1-(1+i)^(-n)](1+i)`

`PV = (PMT)/(0.12) [1-(1+0.12)^(-8)](1+0.12)`

`PV = (42000)/(0.12) [1-(1.12)^(-8)](1.12)`

PV = $233,677.77

For project B , the PV of cash flows at the end of the each year is determined with the use of the expression:

`PV = (PMT)/(i) [1-(1+i)^(-n)]`

`PV = (48000)/(0.12) [1-(1+0.12)^(-7)]`

`PV = (48000)/(0.12) [1-(1.12)^(-7)]`

PV = $219,060.31

Hence, the company should select project A due to the fact that the cashflow is higher.

b) Which project should the company select if the interest rate is 14% at the cash flows in Project B is also at the beginning of each year?

Given that : the new interest rate = 14%;

then :

PV of cahflow for project A is:

`PV = (42000)/(0.14) [1-(1.14)^(-8)](1.14)`

PV = $222,108.80

PV cashflow for project B is:

`PV = (48000)/(0.14) [1-(1.14)^(-7)](1.14)`

PV = $ 234656.04

Here, PV of Cash flow is greater in project B, As such it is best for the company to select Project B