Use the Following Information for the Next Three Questions: Nelson

question 110

Essay

Use the following information for the next three questions: Nelson, Inc. is considering two mutually exclusive projects. Project A is three years long with an initial cash outflow of $10,000 and expected annual inflows of $4,500. Project B is six years long with an initial cash outflow of $18,000 and annual cash inflows of $5,000. The cost of capital is 8%.
A. What is the NPV of the replacement chain for Project A (extending it to six years)?
a. $ 619
b. $1,106
c. $1,597
d. $2,865
e. $5,114
B. What is the equivalent annual annuity (EAA)for the preferred project (A or B)?
a. $ 619
b. $1,106
c. $1,597
d. $2,865
e. $5,114
C. Which of the projects should be selected and why?
a. Project B because its NPV is higher than project A's replacement chain NPV
b. Project A because it has a higher replacement chain NPV
c. Project B because it has a higher IRR
d. Project A because it has a higher EAA
e. Project B because it has a higher replacement chain NPV

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Definitions:

Price Floor

A legally established minimum price for a good, or service. Normally set at a price above the equilibrium price.

Competitive Market

A market structure characterized by a large number of buyers and sellers, free entry and exit, and a high level of competition.

Persistent Shortages

An economic condition where the demand for a good or service consistently exceeds its supply, often due to factors like price controls, causing prolonged scarcity.

Normal Goods

Goods for which demand increases as the income of consumers increases.