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Two financial choices are available. We will compare them using the standard cri

ID: 2761024 • Letter: T

Question

Two financial choices are available. We will compare them using the standard criteria that the annual worth of one is greater than the annual worth than the other. The first choice has an initial investment of 40,000. It generates a yearly revenue of 18000 and at the end of three years has a salvage value of 6000. The second choice has an initial investment of 30,000. It generates a yearly revenue of 12000 and at the end of 6 years has a salvage value of 4000. The interest rate environment is 3%. The management wishes the time Horizon to be 24 years and assume exact repetition of the choice after each time period is completed Analyze the two choices using Annualized Worth.

Explanation / Answer

Year

Particulars

Cash flow

Discount rate@3%

Present value

0

Initial investment

-40000

1

-40000.00

1

Revenue

18000

0.970874

17475.73

2

Revenue

18000

0.942596

16966.73

3

Revenue

18000

0.915142

16472.55

Salvage value

6000

0.915142

5490.85

Total (a)

16405.85

Cumulative discount factor from year 1 to 3 (b)

2.83

Annual worth (c) =(a)/(b)

5799.97

Year

Particulars

Cash flow

Discount rate@3%

Present value

0

Initial investment

-30000

1

-30000.00

1

Revenue

12000

0.970874

11650.49

2

Revenue

12000

0.942596

11311.15

3

Revenue

12000

0.915142

10981.70

4

Revenue

12000

0.888487

10661.84

5

Revenue

12000

0.862609

10351.31

6

Revenue

12000

0.837484

10049.81

Salvage value

4000

0.837484

3349.94

Total (a)

38356.23

Cumulative discount factor from year 1 to 6 (b)

5.42

Annual worth (c) =(a)/(b)

7080.46

Answer: As annual growth of option B is more than option A, the option B will be accepted.


Year

Particulars

Cash flow

Discount rate@3%

Present value

0

Initial investment

-40000

1

-40000.00

1

Revenue

18000

0.970874

17475.73

2

Revenue

18000

0.942596

16966.73

3

Revenue

18000

0.915142

16472.55

Salvage value

6000

0.915142

5490.85

Total (a)

16405.85

Cumulative discount factor from year 1 to 3 (b)

2.83

Annual worth (c) =(a)/(b)

5799.97

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