Question

A firm is must choose to buy the GSU-3300 or the UGA-3000. Both machines make the firm’s production process more efficient which in turn increases incremental cash flows. The GSU-3300 produces incremental cash flows of $25,975.00 per year for 8 years and costs $98,998.00. The UGA-3000 produces incremental cash flows of $27,135.00 per year for 9 years and cost $126,368.00. The firm’s WACC is 7.67%. What is the equivalent annual annuity of the GSU-3300? Assume that there are no taxes.

Answer 1

Equivalent annual annuity (EAA) = (NPV * r) / (1 - (1 + r)-n)

where NPV = net present value

r = required return (WACC)

n = life of of asset in years

NPV is calculated using NPV function in Excel.

EAA of each machine is calculated as below :

Equivalent annual annuity of the GSU-3300 is $8,963.02

Equivalent annual annuity of the UGA-3000 is $7,182.77