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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

EQUIVALENT ANNUAL ANNUITY A firm has two mutually exclusive investment projects to evaluate. The projects have the following cash flows:

Time Cash Flow X Cash Flow Y
0 ($80,000) ($75,000)
1 40,000 35,000
2 60,000 35,000
3 70,000 35,000
4 _ 35,000
5 _ 5,000

Projects X and Y are equally risky and may be repeated indefinitely. If the firm’s WACC is 10%, what is the EAA of the project that adds the most value to the firm? (Round your final answer to the nearest whole dollar.)

Summary Introduction

To Determine: The EAA of the project that adds most value to the firm.

Introduction: EAA or Equivalent annual annuity is a methodology utilized in capital budgeting to pick between mutually exclusive projects with uneven useful lives. The project with greater equivalent annual annuity is chosen.

Explanation

Determine the equivalent annual annuity for Project X

Using a excel spreadsheet and excel function =PMT, the equivalent annual annuity for Project X is determined as $23,540.79.

Excel Spreadsheet:

Excel Workings:

Therefore the equivalent annual annuity of Project X is $23,540.79.

Determine the equivalent annual annuity for Project Y

Using a excel spreadsheet and excel function =PMT, the equivalent annual annuity for Project Y is determined as $23,540...

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