1. Johnson Jets is considering two mutually exclusive projects. Project A has an

Question

1. Johnson Jets is considering two mutually exclusive projects. Project A has an up-front cost of $122,000 (CF0 = -122,000), and produces positive after-tax cash inflows of $30,000 a year at the end of each of the next six years. Project B has an up-front cost of $60,000(CF0 = -60,000) and produces after-tax cash inflows of $20,000 a year at the end of the next four years. Assuming the cost of capital is 10.5%,
1. Compute the equivalent annual annuity of project A. Round the EAA to a whole dollar.
2. Compute the equivalent annual annity of project B.
3. Decide which project to undertake, either Project A or Project B.

2. There are two alternative machines for a manufacturing process. Both machines have the same output rate, but they differ in costs. Machine A costs $20,000 to set up and $8,000 per year to operate. It must be completely replaced every 3 years, and it has no salvage value. Machine B costs $50,000 to set up and $2,160 per year to operate. It should last for 5 years and has no salvage value. The costs of two machines are shown below.

Machine A Machine B

Year 0: 2,000 Year 0: 50.000

Year 1: 8,000 Year 1: 2,160

Year 2: 8,000 Year 2: 2,160

Year 3: 8,000 Year 3: 2,160

Year 4: 0 Year 4: 2,160

Year 5: 0 Year 5: 2,160

Assuming the cost of capital is 10%,
1. Find the equivalent annual cost of Machine A.
2. Find the EAC of Machine B.
3. Based on the equivalent annual cost method, which machine do you recommend, Machine A or Machine B?

Explanation / Answer

1) Statement showing calculation of NPV Project A Project B Particulars Time PVF@10.5% Amount PV(Amount *PVF) Amount PV(Amount *PVF) Cash Outflows                               -                                        1.0000                        (122,000.000)                           (122,000.00)                           (60,000.000)                             (60,000.00) PV of Cash Outflows                           (122,000.00)                             (60,000.00) Cash Inflows                        1.000                                      0.9050                             30,000.000                               27,149.32                             20,000.000                               18,099.55 Cash Inflows                        2.000                                      0.8190                             30,000.000                               24,569.52                             20,000.000                               16,379.68 Cash Inflows                        3.000                                      0.7412                             30,000.000                               22,234.86                             20,000.000                               14,823.24 Cash Inflows                        4.000                                      0.6707                             30,000.000                               20,122.05                             20,000.000                               13,414.70 Cash Inflows                        5.000                                      0.6070                             30,000.000                               18,210.00 Cash Inflows                        6.000                                      0.5493                             30,000.000                               16,479.63 PV of Cash Inflows                             128,765.38                               62,717.17 NPV                                  6,765.38                                  2,717.17 PVF                                          4.29                                          3.14 EAC                                  1,576.20                                     866.47 Undertake project A as it has higher NPV 2) Statement showing calculation of NPV Machine A Mavhine B Particulars Time PVF@10% Amount PV(Amount *PVF) Amount PV(Amount *PVF) Cash Outflows                               -                                        1.0000                           (20,000.000)                             (20,000.00)                           (50,000.000)                             (50,000.00) Cash Outflows                        1.000                                      0.9091                             (8,000.000)                               (7,272.73)                             (2,160.000)                               (1,963.64) Cash Outflows                        2.000                                      0.8264                             (8,000.000)                               (6,611.57)                             (2,160.000)                               (1,785.12) Cash Outflows                        3.000                                      0.7513                             (8,000.000)                               (6,010.52)                             (2,160.000)                               (1,622.84) Cash Outflows                        4.000                                      0.6830                             (2,160.000)                               (1,475.31) Cash Outflows                        5.000                                      0.6209                             (2,160.000)                               (1,341.19) PV of Cash Outflows                             (39,894.82)                             (58,188.10) PVF                                     2.4869                                     3.7908 EAC                             (16,041.99)                             (15,349.82) Machine B should be preffered because of lower EAC

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