Wilson Co. is considering two mutually exclusive projects. Both require an initi

Question

Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,500 at the end of Years 1 and 2, respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has an expected life of 4 years with after-tax cash inflows of $4,600 at the end of each of the next 4 years. Each project has a WACC of 11%. What is the equivalent annual annuity of the most profitable project?

$1,345.50

Explanation / Answer

NPV of Project X is

NPV of Project Y is

Formula for calculation of Equivalent annual annuity is C=r*(NPV)/(1-(1+r)-n)

Applying the formula for project X, NPV =$2304,20

r=11%, n=2

Substituting the values in the above formula C=11% * $2304,20/(1-(1+11%)-2

=$1345.38

Applying the formula for project Y, NPV =$4271.25

r=11%, n=4

Substituting the values in the above formula C=11% * $4271.25/(1-(1+11%)-4

=$1376.74

Therefore, most profitable project is Y and its equivalent annual annuity =$$1376.74

Year Cash outflow/inflow Present value factor Present value 0 -$10,000.00 1 -$10,000.00 1 $6,000.00 0.900901 $5,405.41 2 $8,500.00 0.811622 $6,898.79 NPV $2,304.20

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