Question

Platinum, Inc. is considering two mutually exclusive projects, X and Y. Project X costs $95,000 today and is expected to generate $65,000 in year one and $75,000 in year two. Project Y costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. The firm's investors require a rate of return of 15% and the weighted average cost of capital is 12%. What is the equivalent annual annuity for Project Y needed to compare the two projects

Answer 1

EAA = $17,115.23

Step-by-step explanation:

Please check the attached image for the formula of the equivalent annual annuity

To calculate the EAA, the NPV of project Y has to be determined:

Net present value can be calculated using a financial calculator:

Cash flow in year 0 = $-120,000

Cash flow in year 1 = $64,000

Cash flow in year 2 = $67,000

Cash flow in year 3 = $56,000

Cash flow in year 4 = $45,000

I = 15%

NPV = $48,863.60

EAA = $17,115.23

To find the NPV using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute

I hope my answer helps you