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Faleye Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment...
Faleye Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment (System A) for $19,000, which will generate cash flows of $9,000 at the end of each of the next 6 years. Alternatively, the company can spend $13,000 for equipment that can be used for 3 years and will generate cash flows of $9,000 at the end of each year (System B). If the company’s WACC is 5% 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.
Solutions
Expert Solution
NPV of project A is as follows:
| Year | CF | Discount Factor | Discounted CF | ||
| 0 | $-19,000.00 | 1/(1+0.05)^0= | 1 | 1*-19000= | $ -19,000.00 |
| 1 | $ 9,000.00 | 1/(1+0.05)^1= | 0.952380952 | 0.952380952380952*9000= | $ 8,571.43 |
| 2 | $ 9,000.00 | 1/(1+0.05)^2= | 0.907029478 | 0.90702947845805*9000= | $ 8,163.27 |
| 3 | $ 9,000.00 | 1/(1+0.05)^3= | 0.863837599 | 0.863837598531476*9000= | $ 7,774.54 |
| 4 | $ 9,000.00 | 1/(1+0.05)^4= | 0.822702475 | 0.822702474791882*9000= | $ 7,404.32 |
| 5 | $ 9,000.00 | 1/(1+0.05)^5= | 0.783526166 | 0.783526166468459*9000= | $ 7,051.74 |
| 6 | $ 9,000.00 | 1/(1+0.05)^6= | 0.746215397 | 0.746215396636628*9000= | $ 6,715.94 |
| NPV = Sum of all Discounted CF | $ 26,681.23 |
NPV of projct B is:
| Year | CF | Discount Factor | Discounted CF | ||
| 0 | $-13,000.00 | 1/(1+0.05)^0= | 1 | 1*-13000= | $ -13,000.00 |
| 1 | $ 9,000.00 | 1/(1+0.05)^1= | 0.952380952 | 0.952380952380952*9000= | $ 8,571.43 |
| 2 | $ 9,000.00 | 1/(1+0.05)^2= | 0.907029478 | 0.90702947845805*9000= | $ 8,163.27 |
| 3 | $ -4,000.00 | 1/(1+0.05)^3= | 0.863837599 | 0.863837598531476*-4000= | $ -3,455.35 |
| 4 | $ 9,000.00 | 1/(1+0.05)^4= | 0.822702475 | 0.822702474791882*9000= | $ 7,404.32 |
| 5 | $ 9,000.00 | 1/(1+0.05)^5= | 0.783526166 | 0.783526166468459*9000= | $ 7,051.74 |
| 6 | $ 9,000.00 | 1/(1+0.05)^6= | 0.746215397 | 0.746215396636628*9000= | $ 6,715.94 |
| NPV = Sum of all Discounted CF | $ 21,451.34 |
In the year 3 the CF is 9000-13000 = -4000 as the project is repeated.
Even after repetition the NPV is higher for project A so it should be selected
EAA for each project is calculated as follows:
Project A:
We are given the following information:
| EAA | PMT | To be calculated |
| WACC | r | 5.00% |
| Number of years | n | 6 |
| NPV | PV | $ 26,681.23 |
We need to solve the following equation to arrive at the
required EAA:
Project B:
We are given the following information:
| EAA | PMT | To be calculated |
| WACC | r | 5.00% |
| Number of years | n | 6 |
| NPV | PV | $ 21,451.34 |
We need to solve the following equation to arrive at the
required EAA:
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