Question

Faleye Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment (System A) for $21,000, which will generate cash flows of $10,000 at the end of each of the next 6 years. Alternatively, the company can spend $12,000 for equipment that can be used for 3 years and will generate cash flows of $10,000 at the end of each year (System B). If the company’s WACC is 10% and both “projects” can be repeated indefinitely, which system should be chosen, and what is its EAA? Do not round intermediate calculations. Round your answer to the nearest cent.

Choose Project -Select-(A, B), whose EAA = $  

Answer 1

System A
Initial cost	21,000.00	$
Life	6	Years
cash inflows	10,000.00	$
Rate	10.00	%

Year	PV factor 10% [1/(1+r)^n]
1	0.909
2	0.826
3	0.751
4	0.683
5	0.621
6	0.564
Total	4.355

NPV = Discounted inflow - Initial investment
Discounted inflow = Annual inflow * total PV factor
=	10000 * 4.355
=	43,550.00
NPV=	43550 - 21000
=	22,550.00
EAA=	NPV / Total PV factor
=	22550 / 4.355
=	5,177.96

System B
Initial cost	12,000.00	$
Life	3	Years
cash inflows	10,000.00	$
Rate	10.00	%

Year	PV factor 10% [1/(1+r)^n]
1	0.909
2	0.826
3	0.751
Total	2.487

NPV = Discounted inflow - Initial investment
Discounted inflow = Annual inflow * total PV factor
=	10000 * 2.487
=	24,870.00
NPV=	24870 - 12000
=	12,870.00
EAA=	NPV / Total PV factor
=	12870 / 2.487
=	5,174.91

Project	EAA
A	5,177.96	$
B	5,174.91	$
Since project A has highest EAA, Project A should be undertaken