Question

What is the equivalent annual annuity of a project that requires an investment of $50,000 today and is expected to generate free cash flows of $15,000 per year for the next five years? The company’s weighted average cost of capital is 13.1% per year.

Answer 1

$749.57

Step-by-step explanation:

equivalent annual annuity = (NPV x rate) / [1 - (1 + rate)⁻ⁿ]

• using a calculator, the NPV = $2,630
• rate = 13.1%
• n = 5

equivalent annual annuity = ($2,630 x 0.131) / [1 - (1 + 0.131)⁻⁵] = $344.53 / 0.4596 = $749.57

The equivalent annual annuity is used to compare mutually exclusive projects and determine which yields the highest annual returns.