Answer:
The discount rate of 8% for 11 year period provides the present value of annual cash flows to be equal to the initial investment.
Explanation:
Using the table of present value of annuity provided, we can check the rate and time period which is return the present value of cash flows from the project to be equal to initial Investment.
We are told that the Project's life is expected to be 11 Years. Thus using the 11 year period from the table we can see the following rates,
<u>11 Year Period</u>
Rate = 5% , Annuity Factor = 8.3064
Rate = 6% , Annuity Factor = 7.8869
Rate = 7% , Annuity Factor = 7.4987
Rate = 8% , Annuity Factor = 7.1390
Rate = 9% , Annuity Factor = 6.8052
We know that the annual cash flows from the project is $1,000,000 and we know the Initial Outlay is $7,139,000.
Multiplying the annual cash flow from the above annuity factors for each rate we can see which rate provides the present value of annual cash flows to be equal to initial outlay.
Rate = 5% , Present value = 8.3064 * 1000000 = $8,306,400
Rate = 6% , Annuity Factor = 7.8869 * 1000000 = $7,886,900
Rate = 7% , Annuity Factor = 7.4987 * 1000000 = $7,498,700
Rate = 8% , Annuity Factor = 7.1390 * 1000000 = $7,139,000
Rate = 9% , Annuity Factor = 6.8052 * 1000000 = $6,805,200
From the above calculation we can see that the rate of 8% provides the present value of annual cash flows to be equal to the initial investment.
