Johnson Jets is considering two mutually exclusive projects. Project A has an up
ID: 2759720 • Letter: J
Question
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 in box 1. Round the EAA to a whole dollar without the dollar sign or comma, e.g., 3452 (non-negative number) 2. Compute the equivalent annual annity of project B in box 2. The same format as box 1. 3. Decide which project to undertake in box 3, either Project A or Project B.
Explanation / Answer
1. Equivalent annual annuity of project A
We need to calculate the NPV of the project A first
The NPV of Project A = $6,765.38
Equivalent annual annuity = C = r(NPV)/ [1- (1+r)^-n] = 0.105*6765.38/[1-(1+0.105)^-6] = $1,576.21
Equivalent annual annuity of project A = $1,576.21
2. Equivalent annual annuity of project B
We need to calculate the NPV of the project B first
The NPV of Project B = $2,717.17
Equivalent annual annuity = C = r(NPV)/ [1- (1+r)^-n] = 0.105*2717.17/[1-(1+0.105)^-4] = $866.48
Equivalent annual annuity of project B = $866.48
3. Project A is to be selected since it has a higher equivalent annual annuity
Year Cash flow Discounted CF at 10.5% 0 -122000 -122000 1 30000 27149.32127 2 30000 24569.52151 3 30000 22234.86109 4 30000 20122.04624 5 30000 18209.9966 6 30000 16479.63493 NPV $ 6,765.38Related Questions
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