Question

Giant Equipment Ltd. is considering two projects to invest next year. Both projects have the same

Answer 1

Answer:

Explanation:

Given that :

Project A will produce annual cash flows of $42,000 at the beginning of each year for  eight years.

Project B will produce cash flows of $48,000 at the end of each year for seven years.

Return rate = 12% = 0.12

a) Which project should the company select and why?

To determine the project which the company should select; let find the PV of cash flow:

For project A; PV of cash flows at the beginning of the each year is determined with the use of the expression:

$PV = \frac{PMT}{i} [1-(1+i)^{-n}](1+i)$

$PV = \frac{PMT}{0.12} [1-(1+0.12)^{-8}](1+0.12)$

$PV = \frac{42000}{0.12} [1-(1.12)^{-8}](1.12)$

PV = $233,677.77

For project B , the PV of cash flows at the end of the each year is determined with the use of the expression:

$PV = \frac{PMT}{i} [1-(1+i)^{-n}]$

$PV = \frac{48000}{0.12} [1-(1+0.12)^{-7}]$

$PV = \frac{48000}{0.12} [1-(1.12)^{-7}]$

PV  = $219,060.31

Hence, the company should select project A due to the fact that the cashflow is higher.

b) Which project should the  company select if the interest rate is 14% at the cash flows in Project B  is also at the beginning of each year?

Given that : the new interest rate = 14%;

then :

PV of cahflow for project A is:

$PV = \frac{42000}{0.14} [1-(1.14)^{-8}](1.14)$

PV = $222,108.80

PV cashflow for project B is:

$PV = \frac{48000}{0.14} [1-(1.14)^{-7}](1.14)$

PV  = $ 234656.04

Here, PV of Cash flow is greater in project B, As such it is best for the company to select Project B