Assumption University Graduate School Of E-Learning 6405 Ad

Assumption University Graduate School Of Elearningms 6405 Advanced F

Assumption University Graduate School Of Elearningms 6405 Advanced F

Assumption University Graduate School of eLearning MS 6405: Advanced Finance Dr. Kanix Bukkavesa, CFA Midterm Exam Use EAC method. There are 2 new projects, and assume WACC is 8.5%. What is the EAC for each project? From the EAC, which one should you select?

The cash flows for each project are as follows:

- Machine A: Costs $19,500; annual cash inflows of $5,600; life of 4 years.

- Machine B: Costs $12,400; annual cash inflows of $4,620; life of 3 years.

Calculate the EAC for each project and determine which project to select.

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Assumption University Graduate School Of Elearningms 6405 Advanced F

Use EAC method. There are 2 new projects, and assume WACC is 8.5%. What is the EAC for each project? From the EAC, which one should you select?

The cash flows for each project are as follows:

  • Machine A: Costs $19,500; annual cash inflows of $5,600; life of 4 years.
  • Machine B: Costs $12,400; annual cash inflows of $4,620; life of 3 years.

Calculate the EAC for each project and determine which project to select based on the lower EAC.

Paper For Above instruction

The evaluation of capital investment projects is crucial for strategic financial decision-making, especially when companies are faced with multiple options. The Equivalent Annual Cost (EAC) method provides a way to compare projects with different lifespans by transforming their net present values into a uniform annual figure. This method enables managers to make informed choices to maximize value, considering the time value of money and project durability

Given the data, we will proceed to calculate the EAC for each project using the provided WACC of 8.5%. First, determine the present value of the initial investment and then annualize this cost over each project's lifespan.

For Machine A, with a cost of $19,500 and a lifespan of four years, the discount rate (WACC) is 8.5%. The present value of the initial investment is straightforward since it's an upfront cash outflow. To find the annual equivalent cost, we calculate the capital recovery factor and then divide the initial investment by this factor. The capital recovery factor (CRF) at 8.5% for 4 years is:

CRF = r(1 + r)^n / [(1 + r)^n - 1] = 0.085 (1 + 0.085)^4 / [(1 + 0.085)^4 - 1] = 0.085 1.4233 / (1.4233 - 1) ≈ 0.085 * 1.4233 / 0.4233 ≈ 0.2859 / 0.4233 ≈ 0.6758

Therefore, the EAC for Machine A is calculated by dividing the initial investment by the capital recovery factor:

EAC_A = $19,500 CRF = $19,500 0.2859 ≈ $5,570.55

Similarly, for Machine B, with a cost of $12,400 and a lifespan of three years, the capital recovery factor at 8.5% is:

CRF = 0.085 (1 + 0.085)^3 / [(1 + 0.085)^3 - 1] = 0.085 1.276 / (1.276 - 1) ≈ 0.085 * 1.276 / 0.276 ≈ 0.1084 / 0.276 ≈ 0.3934

Consequently, the EAC for Machine B is:

EAC_B = $12,400 CRF = $12,400 0.3934 ≈ $4,878.24

It is important to note that the annual cash inflows should be compared against these EAC figures to determine the economic viability of each project. Given that the annual cash inflows are significant relative to the EAC, both projects could potentially be profitable. However, based on the EAC alone, Machine B has a lower EAC of approximately $4,878.24, indicating it is the more cost-effective option.

In conclusion, considering the lower EAC, the firm should select Machine B for investment. This choice ensures the lowest annualized cost when distributing the initial investment over the project's lifespan, thus optimizing capital allocation and maximizing return on investment.

References

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