Suppose you are working in the finance department of a well-

reputed organization. Management of the organization has

given you two alternate projects and assigned you a task to
select a short-term project on the basis of Net Present Value
(NPV).  The life span of both projects is different which causes
the problem for accurate selection of a project. It is the norm of
the industry if the projects have different life span; there are
two standard methods to equate them at one point of time. First
is the Common Life Approach (CLA); second is Equivalent
Annual Annuity Approach (EAA) as both provide better result
in case of uneven lives of projects under consideration.

 Following information has been provided about two projects

by the management:

Initial Cash flow Cash flow NPV

Project investment year 1 year 2
(Rs)
(Rs) (Rs) (Rs)
A 500,000 1,000,000 - 392,857
B 1,000,000 1,000,000 1,000,000 690,051
 

NPV under Common Life Approach (CLA)

 
Project Initial Cash flow Cash flow NPV
investment year 1 year 2
(Rs)
  (Rs) (Rs)  
A 500,000 1,000,000 - 743,622.5
B 1,000,000 1,000,000 1,000,000 690,050.9
Requirements:

You are advised to calculate NPV by EAA method if discount

rate is 12% and suggest best one to the management along with
the solid reason.

1. Calculate EAA FACTOR of both projects.

2. Calculate NPV of both projects by EAA Approach.
3. Based on the calculations, which project you will suggest
and why? Do CLA and EAA methods have led to same
 decision about the selection of project? (Your selection
should be supported with logical reasoning)

Note: Complete Calculations for EAA factor and NPV is

mandatory as it carries marks; marks will be deducted on
providing just answers).

Important Instructions:

 Post your GDB comments (answer) against GDB # 01

rather than against lessons’ MDB.
 Your discussion must be based on logical facts.
 Do not copy or exchange your answer with other
students.  Two identical / copied comments will be
marked Zero (0) and may damage your grade in the
course.
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which may be posted by the students on MDB or via e-
mail, will not be replied till the due date of GDB.

For Detailed Instructions, please read the GDB # 01

announcement.

Best of Luck!!
Teacher’s Comment/Solution

SOLUTION

1.EAA Factor

Project A
Formula

EAA Factor =(1+i)^n/[(1+i)^n-1]

=(1+0.12)^1/[(1+0.12)^1-1]

=1.12/(1.12-1)

=9.33333

Project B

Formula

 EAA Factor =(1+i)^n/[(1+i)^n-1]

=(1+0.12)^2/[(1+0.12)^2-1]

=1.2544/(1.2544-1)

=4.93081

2.NPV BY EAA

Project A

EAA=Simple NPV*EAA Factor

=392857.14*9.33

=3665355

Project B

EAA=Simple NPV*EAA Factor

=690051*4.93

=3402510

Q.3
Project A is better due to having NPV higher than Project B
according to both methods CLA and EAA.