EQUIVALENT ANNUAL ANNUITIES 1. Black Sheep broadcasting is considering a five ye
ID: 2383490 • Letter: E
Question
EQUIVALENT ANNUAL ANNUITIES
1. Black Sheep broadcasting is considering a five year-project that has a weighted average cost of capital of 12% and a net present value (NPV) of $56,489. Black sheep broadcasting can replicate this project indefinitely.
What is the equivalent annual annuity (EAA) for this project?
a. $13,320
b. $19,589
c. $15,671
d. $14,104
2. An analyst will need to use the EAA approach to evaluate projects with unequal live when the projects are ________.
a. Mutually exclusive OR
b. Independent
Explanation / Answer
1. Option C.
The equivalent annual annuity (EAA) approach calculates the constant annual cash flow generated by a project over its lifespan if it was an annuity. The present value of the constant annual cash flows is exactly equal to the project's net present value (NPV).
Equivalent Annual Annuity (EAA) = Net Present Value/(1 (1 + Discount Rate)-life of the project / discount rate)
= $56,489 / (1-(1+12%)^-5)/12%)
= $15,670 or $15,671 Ans.
2. An analyst will need to use the EAA approach to evaluate projects with unequal live when the projects are ________.
a. Mutually exclusive
(Equivalent annual annuity (EAA) is an approach used in capital budgeting to choose between mutually exclusive projects with unequal useful lives. It assumes that the projects are annuities, calculates net present value for each project, and then finds annual cash flows that when discounted at the relevant discount rate for the life of the relevant project, would equal the net present value for that project.)
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