In: Finance
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 $124,499.00. The firm’s WACC is 9.38%. What is the equivalent annual annuity of the GSU-3300?
Equivalent Annual Annuity (EAA) of the GSU-3300
| 
 Year  | 
 Annual Cash Inflow ($)  | 
 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.