Financial ManagementQuestion 5529 of 217
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7. T Ltd. is looking for a capital project in order to replace its existing old machine. It got two proposals to consider; details of which are given below: Proposal X Proposal Y Initial investment ` 6,50,000 ` 7,80,000 Estimated useful life 5 Years 3 Years Annal cash inflows ` 1,90,000 ` 3,50,000 Cost of capital 10% 10% Year 1 2 3 4 5 PVIF0.10, t 0909 0.826 0.751 0.683 0.621 PVIFA0.10, t 0.909 1.736 2.487 3.170 3.791 What will be Equivalent Annual NPV for Proposal X and Proposal Y?

Options

A` 70,290.00, ` 90,450.00
B` 18,541.28, ` 36,369.12
C` 1,90,000.00, ` 3,50,000.00
D` 77,326.73, ` 99,504.95 (2 Marks)
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Correct Answer

Option B` 18,541.28, ` 36,369.12

All Options:

  • A` 70,290.00, ` 90,450.00
  • B` 18,541.28, ` 36,369.12
  • C` 1,90,000.00, ` 3,50,000.00
  • D` 77,326.73, ` 99,504.95 (2 Marks)

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Detailed Solution & Explanation

Correct Answer: Option **B**

**Explanation:**
Equivalent Annual NPV (EANPV) is used to compare projects with unequal lives. The formula for EANPV is:
textEANPV=fractextNetPresentValue(NPV)textPVIFA(k,n)\\text{EANPV} = \\frac{\\text{Net Present Value (NPV)}}{\\text{PVIFA}(k, n)}
Where:
- textNPV=textPVofCashInflowstextInitialInvestment\displaystyle \\text{NPV} = \\text{PV of Cash Inflows} - \\text{Initial Investment}
- textPVofCashInflows=textAnnualCashInflowtimestextPVIFA(k,n)\displaystyle \\text{PV of Cash Inflows} = \\text{Annual Cash Inflow} \\times \\text{PVIFA}(k, n)
- textPVIFA(k,n)\displaystyle \\text{PVIFA}(k, n) is the Cumulative Present Value Interest Factor of Annuity at cost of capital k\displaystyle k for n\displaystyle n years.

**1. For Proposal X:**
- textInitialInvestment=text6,50,000\displaystyle \\text{Initial Investment} = \\text{₹ } 6,50,000
- textUsefulLife(n)=5textYears\displaystyle \\text{Useful Life } (n) = 5\\text{ Years}
- textAnnualCashInflow=text1,90,000\displaystyle \\text{Annual Cash Inflow} = \\text{₹ } 1,90,000
- textCostofCapital(k)=10\displaystyle \\text{Cost of Capital } (k) = 10\\%
- From the given table, textPVIFA(10\displaystyle \\text{PVIFA}(10\\%, 5\\text{ years}) = 3.791
- textPVofCashInflows=1,90,000times3.791=text7,20,290\displaystyle \\text{PV of Cash Inflows} = 1,90,000 \\times 3.791 = \\text{₹ } 7,20,290
- textNPVX=7,20,2906,50,000=text70,290\displaystyle \\text{NPV}_X = 7,20,290 - 6,50,000 = \\text{₹ } 70,290
- textEANPVX=frac70,2903.791approxtext18,541.28\displaystyle \\text{EANPV}_X = \\frac{70,290}{3.791} \\approx \\text{₹ } 18,541.28

**2. For Proposal Y:**
- textInitialInvestment=text7,80,000\displaystyle \\text{Initial Investment} = \\text{₹ } 7,80,000
- textUsefulLife(n)=3textYears\displaystyle \\text{Useful Life } (n) = 3\\text{ Years}
- textAnnualCashInflow=text3,50,000\displaystyle \\text{Annual Cash Inflow} = \\text{₹ } 3,50,000
- textCostofCapital(k)=10\displaystyle \\text{Cost of Capital } (k) = 10\\%
- From the given table, textPVIFA(10\displaystyle \\text{PVIFA}(10\\%, 3\\text{ years}) = 2.487
- textPVofCashInflows=3,50,000times2.487=text8,70,450\displaystyle \\text{PV of Cash Inflows} = 3,50,000 \\times 2.487 = \\text{₹ } 8,70,450
- textNPVY=8,70,4507,80,000=text90,450\displaystyle \\text{NPV}_Y = 8,70,450 - 7,80,000 = \\text{₹ } 90,450
- textEANPVY=frac90,4502.487approxtext36,369.12\displaystyle \\text{EANPV}_Y = \\frac{90,450}{2.487} \\approx \\text{₹ } 36,369.12

Thus, the Equivalent Annual NPV for Proposal X is ₹ 18,541.28 and for Proposal Y is ₹ 36,369.12.

Hence, **Option B** is the correct answer.

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