Question

Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $9,100 at t = 0. Project X has an expected life of 2 years with after-tax cash inflows of $5,500 and $9,400 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 $3,800 at the end of each of the next 4 years. Each project has a WACC of 9%. What is the equivalent annual annuity of the most profitable project? Do not round intermediate calculations.

Answer 1

Based on the cash flows of the two projects, the equivalent annual annuity of the most profitable project is $1,866.83.

Which project is more profitable?

The project that is more profitable is the project with the higher Net Present Value.

The Net Present value can be found by adding the present values of the cashflows for a project.

Project X NPV is:

= -9,100 + 5,500 / 1.11 + 8,200 / 1.11²

= $2,510.26

The NPV for Project Y is:

= -9,100 + Present value of $4,800 over 4 years at 11%

= $5,791.74

The more profitable project is therefore Project Y.

The equivalent annual annuity of the most profitable project is:

= 5,791.74 / 4 years

= $1,866.83

In conclusion, the equivalent annual annuity of the most profitable project is $1,866.83

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