Question

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 $25,017.00 per year for 8 years and costs $103,271.00. The UGA-3000 produces incremental cash flows of $27,017.00 per year for 9 years and cost $126,508.00. The firm’s WACC is 9.02%. What is the equivalent annual annuity of the UGA-3000? Assume that there are no taxes.

Answer 1

Please find the solution :

Solution

1) Concept

Equivalent annual annuity (EAA) is an approach used in capital budgeting to choose between mutually exclusive projects with unequal useful lives.

2) Formula

3) Calculation

> NPV

- GSU-3300

NPV = PVAF (9.02%, 8) * 25017 - 103271

        = 5.5307 * 25017 - 103271

        = $ 35091

- UGA-3000

NPV = PVAF (9.02%, 9) * 25017 - 126508

        = 5.9904 * 27017 - 126508

        = $ 35335

> EAA

- GSU-3300

= (0.0902 * 35091) / 1 - (1.0902)-8

= $ 6344.76

- UGA - 3000

= (0.0902 * 35335) / 1 - (1.0902)-9

= $ 5898.63 Answer