Question

Alpha & Omega wants to invest in a new computer system, and management has narrowed the choice to Systems A and B.

System A requires an up-front cost of $100,000, after which it generates positive after-tax cash flows of $70,000 at the end of each of the next 2 years. The system could be replaced every 2 years, and the cash inflows and outflows would remain the same.

System B also requires an up-front cost of $100,000, after which it would generate positive after-tax cash flows of $48,000 at the end of each of the next 3 years. System B can be replaced every 3 years, but each time the system is replaced, both the cash outflows and cash inflows would increase by 10%.

The company needs a computer system for 6 years, after which the current owners plan to retire and liquidate the firm. The company's cost of capital is 14%.

--what is the equivalent annual annuity (EAA) for System B?

Answer 1