Answer:
1. If this is accepted the value of the company will increase by $27.0084 million.
2. The equivalent annual annuity for each plane:
Plane A = $2.973 million
Plane B = $4.586 million
Explanation:
1. Let's calculate Net Present Value (NPV) for Plane A:
Initial investment = $100 million
Annual cash flows = $30 million per year
Cost of capital = 11%
n = 5 years
NPV = (Annual cash flows × PVIFA (Cost of capital, n) - Initial investment
where PVIFa is Present Value Interest Factor
NPV = (30 million ×PVIFA (11%, 5) - 100 million
NPV = (30 million × 3.659) - 100 million
NPV = $10.877 million
Let's calculate Net Present Value (NPV) for Plane B:
Initial investment = $132 million
Annual cash flows = $27 million per year
Cost of capital = 11%
n = 10 years
NPV = (Annual cash flows × PVIFA (Cost of capital, n) - Initial investment
where PVIFa is Present Value Interest Factor
NPV = ($27 million ×PVIFA (11%, 10) - $132 million
NPV = ($27 million × 5.8892) - $132 million
NPV = $27.0084 million
In conclusion, the better project is Plane B as it has a higher net present value. If this is accepted the value of the company will increase by $27.0084 million.
2. equivalent annual annuity = NPV/ Present Value Annuity Factor
For Plane A:
equivalent annual annuity = NPV/ Present Value Annuity Factor ( 11%, 5)
equivalent annual annuity = $10.877 million/ 3.659
equivalent annual annuity = $2.973 million
The equivalent annual annuity for plane A is $2.973 million
For Plane B:
equivalent annual annuity = NPV/ Present Value Annuity Factor ( 11%, 10)
equivalent annual annuity = $27.0084 million/5.8892
equivalent annual annuity = $4.586 million
The equivalent annual annuity for plane B is $4.586 million
