Question

Coiner Clothes Inc. is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: (a) Machine 200-3, which has a cost of $200,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $90,000 per year, and (b) Machine 380-6, which has a cost of $380,000, a 6-year life, and after-tax cash flows of $100,000 per year. Assume that both projects can be repeated. Knitting machine prices are not expected to rise because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Coiner's WACC is 14%. What is the equivalent annual anuity of the project that should be selected?

Answer 1

Solution :

The Equivalent annual annuity of Machine 200 - 3 is = $ 3,853.7039

= $ 3,853.70 ( when rounded off to two decimal places )

The Equivalent annual annuity of Machine 380 - 6 is = $ 2,280.1517

= $ 2,280.15 ( when rounded off to two decimal places )

The project which has the higher EAA should be selected as it would result in a higher Equivalent annual cash inflow

Thus Machine 200 - 3 which has the higher Equivalent Annuity of $ 3,853.70 shall be selected.

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.