CA Intermediate · Financial Management and Strategic Management · Investment Decisions
Sundaram Foods must choose between two machines with unequal lives and plans to replace whichever it picks. Machine X has a life of 5 years and an NPV of ₹1,13,730 at the cost of capital of 10%. The PV annuity factor for 5 years at 10% is 3.791. What is the equivalent annual annuity (EAA) of Machine X?
The equivalent annual annuity is ₹30,000, found by dividing the project's NPV of ₹1,13,730 by the 5-year, 10% annuity factor of 3.791. It converts NPV into an annual equivalent, so projects with unequal lives can be compared fairly.
- A₹30,000Correct
- B₹22,746
- C₹11,373
- D₹1,13,730
Explanation
EAA = NPV / annuity factor = 1,13,730 / 3.791 = ₹30,000. Dividing NPV by the number of years (₹22,746) is wrong as it ignores discounting. Multiplying NPV by 10% gives ₹11,373, which is also wrong. EAA allows comparison of projects with unequal lives.
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