Question

RainMan Inc. is in the business of producing rain upon request. They must decide between two investment projects: a new airplane for seeding rain clouds or a new weather control machine built by Dr. Nutzbaum. The discount rate for the new airplane is 9 percent, while the discount rate for the weather machine is 39 percent (it happens to have higher market risk). Which investment should the company select and why

Answer 1

Complete data:

Year___AirplaneWeather __ Machine

0 _______–90 _________ –900

1 _______500 ___________550

2 _______600 ____ ______600

3 _____________________685

Answer:

Weather machine, because it has a higher equivalent annual cash flow.

Explanation:

Discount rate :

New airplane = 9% = 0.09

Weather machine = 39% = 0.39

Calculate the Equivalent annual cashflow of each :

Using the relation :

New airplane :

(-900+500/1.09) + (600/1.09^2) * 0.09 / (1-1/1.09^2)

(−900+500÷1.09+600÷1.09^2)×9%÷(1−1÷1.09^2)

= 36.2249

Equivalent Annual cashflow of Weather Machine=(−900+550÷1.39+600÷1.39^2+685÷1.39^3)×0.39÷(1−1÷1.39^3)

= 38.0828

Based on the result of the equivalent annual cashflow, the company should opt for investing in weather machine.