Your company is considering starting a project in either Italy or Thailand - and are mutually exclusive.
Italian project is a 6 year project with the following expected cash flows:
Year 0 = -$975,000
Year 1 = 350,000
Year 2 = 370,000
Year 3 = 390,000
Year 4 = 320,000
Year 5 = 115,000
Year 6 = 80,000
The Thai project is a 3 year project; however the company plans to repeat the project after 3 years. The expected cash flows are:
Year 0 = -$490,000
Year 1 = 250,000
Year 2 = 265,000
Year 3 = 275,000
Due to the project unequal lives, use the annual annuity approach to evaulate them, the approprite cost of capital for both project is 9%. What is the NPV of both projects?
What is the equivalent annual annuity (EAA) for the Thai project?
What is the EAA for the Italian project?
If the CFO uses the EAA approach to decide which project to undertake, he should choose the Thai/Italian project because it has the highest/lowest EAA.