Capital Budgeting: What is the Equivalent Annual Annuity (EAA) for this project?

Question

Capital Budgeting: What is the Equivalent Annual Annuity (EAA) for this project?

Another method to deal with the unequal life problem of projects is the equivalent annual annuity (EAA) method. In this method the annual cash flows under the alternative investments are converted into a constant cash flow stream whose NPV is equivalent to the NPV of the comparative project's initial stream. Consider the case of Black Sheep Broadcasting: Black Sheep Broadcasting is considering a four-year project that has a weighted average cost of capital of 13% and a net present value (NPV) of $90,760. Black Sheep Broadcasting can replicate this project indefinitely. What is the equivalent annual annuity (EAA) for this project? $25,936 $30,513 $28,987 $33,564 An analyst will need to use the EAA approach to evaluate projects with unequal lives when the projects are independent mutually exclusive

Explanation / Answer

Equivalent annual annuity = present value/ PV of annuity = 90760/ 2.97 = $30567

Refer present value of annuity table for 13% @4years = 2.97

When the projects are mutually exclusive, an analyst can use EAA approach for different life.

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