CA Intermediate · Financial Management and Strategic Management · Investment Decisions
Kaveri Industries must choose between two machines with unequal lives. Machine X has a 3-year life and an NPV of ₹2,48,700 at a 10% cost of capital. The 3-year annuity factor at 10% is 2.487. What is the equivalent annual annuity (EAA) of Machine X?
The equivalent annual annuity is ₹1,00,000. It is found by dividing the project's NPV of ₹2,48,700 by the 3-year annuity factor of 2.487 at 10%. Simply dividing NPV by three years ignores discounting and would understate the annual benefit.
- A₹82,900
- B₹1,00,000Correct
- C₹2,48,700
- D₹78,450
Explanation
EAA = NPV / annuity factor for the project's life = 2,48,700 / 2.487 = ₹1,00,000. Dividing NPV by 3 years (₹82,900) ignores the time value of money. Using the 4-year factor of 3.170 gives about ₹78,450, which applies the wrong life.
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