Question

In: Finance

A firm is must choose to buy the GSU-3300 or the UGA-3000. Both machines make the...

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 $25,369.00 per year for 8 years and costs $98,580.00. The UGA-3000 produces incremental cash flows of $29,543.00 per year for 9 years and cost $124,499.00. The firm’s WACC is 9.38%. What is the equivalent annual annuity of the GSU-3300?

Solutions

Expert Solution

Equivalent Annual Annuity (EAA) of the GSU-3300

Year

Annual Cash Inflow ($)

Present Value factor at 9.38%

Present Value of Annual Cash Inflow ($)

1

25,369

0.914244

23,193.45

2

25,369

0.835842

21,204.47

3

25,369

0.764163

19,386.06

4

25,369

0.698632

17,723.59

5

25,369

0.638720

16,203.68

6

25,369

0.583946

14,814.12

7

25,369

0.533869

13,543.72

8

25,369

0.488086

12,382.26

TOTAL

5.457502

1,38,451.36

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $138,451.36 - $98,580

= $39,871.36

Equivalent Annual Annuity (EAA) = Net Present Value / [PVIFA 9.38%, 8 Years]

= $39,871.36 / 5.45752

= $7,305.79 per year

“Hence, the Equivalent Annual Annuity (EAA) of the GSU-3300 would be $7,305.79”

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.


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