Question

Cotner Clothes Inc. is considering the replacement of its old knitting machine. Two new models
are available:
a) Machine 190-3, which has a cost of $190,000, a 3-year expected life, and after-tax cash flows of $87,000 per year.
b) Machine 360-6, which has a cost of $360,000, a 6-year expected life, and after-tax cash flows of $98,000 per year.


Assume Cotner's WACC is 14%. Calculate the equivalent annual annuity (EAA) of Machine 190-3.

Assume Cotner's WACC is 14%. Calculate the equivalent annual annuity (EAA) of Machine 360-6.

Answer 1

Calculation of Equivalent Annual Annuity

Machine 190-3

1. Equivalent Annual Cost = Machinery cost / Cumuclative discount factor @14% for 3 years

= 190000/2.321632

= 81838.98

2. Equvalent Annuty = Annual cash flows - Equavelent annual cost

= 87000 -81838.98

= 5161.02

Machine 360-6

1. Equivalent Annual Cost = Machinery cost / Cumuclative discount factor @14% for 6 years

= 360000/3.888667

= 92576.71

2. Equvalent Annuty = Annual cash flows - Equavelent annual cost

= 98000 - 92576.71

= 5423.29