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.