Solved problem on annual equivalent method – 1
Solved problem on annual equivalent method – 1
A
company invests in one of the two mutually exclusive alternatives. The life of
both alternatives to be 6 years with the following details.
Details
|
Alternative A
|
Alternative B
|
Investment
(₹)
|
₹.
2,00,000
|
₹.2,25,000
|
Annual
equal return (₹)
|
₹.
60,000
|
₹.
65,000
|
Salvage
value (₹)
|
₹.
20,000
|
₹.
30,000
|
Determine
the best alternative based on annual equivalent method at i = 20%, compounded
annually.
Given data
Method
= Annual equivalent method - Revenue dominated cash flow
i
= 20%
n
= 6
Alternative 1
P
= ₹. 2,00,000
A1
= A2 = … = A6 = A = ₹.
60,000
S
= ₹. 20,000
Alternative 2
P
= ₹. 2,25,000
A1
= A2 = … = A6 = A = ₹.
65,000
S
= ₹. 30,000
Formula used
AE(i) = -P (A/P, i, n) + A + S (A/F, i, n)
Solution
Alternative 1
AE(20%)1 = -2,00,000 (A/P, 20%, 6) + 60,000 + 20,000
(A/F, 20%, 6)
= -2,00,000 (0.3007) + 60,000 +
20,000 (0.1007)
= - 60,140 + 60,000 + 2014
AE(20%)1 = ₹. 1,874
Alternative 2
AE(20%)2 = -2,25,000 (A/P, 20%, 6) + 65,000 + 30,000
(A/F, 20%, 6)
= -2,25,000 (0.3007) + 65,000 + 30,000
(0.1007)
= - 67,657.5 + 65,000 + 3021
AE(20%)2 = ₹. 363.5
Result
In annual equivalent
revenue method, the alternative which has maximum annual equivalent revenue is
the best alternative. Therefore alternative 1 is the best alternative.
