Consider the following two investment alternatives, in which Alternative II is m

Question

Consider the following two investment alternatives, in which Alternative II is more economically attractive than Alternative I: Alternative I Alternative II Initial Investment $10,000 $40,000 Useful life 5 years 10 years Terminal market value $1,000 $5,000 Annual expenses $14,750 $7,000 EUAC (12%), approx. $17,367 $13,800 Determine the percent change in the annual expenses for Alternative I that would make the two investments equally attractive. (Enter your answer as a positive or negative number without the percent % sign.)

Explanation / Answer

Solution:

EUAC = [Asset Price*Discount Rate] / [1 - (1 + Discount Rate) - Number of Periods ] + Annual Expenses

In Alternative 1,

EUAC = 17367

or, 17367 = 2617 + 14750

Therefore,

[Asset Price*Discount Rate] / [1 - (1 + Discount Rate) - Number of Periods ] = $ 2617

Now,

EUAC 2 = EUAC 1

or, 13800 = 2617 + Revised Annual Expenses

or, Revised Annual Expense = 11183

Therefore,

Percentage change in annual expense = (11183 - 14750)/14750

= - 0.24183

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