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 $24,784.00 per year for 8 years and costs $104,094.00. The UGA-3000 produces incremental cash flows of $28,017.00 per year for 9 years and cost $123,395.00. The firm’s WACC is 9.54%. What is the equivalent annual annuity of the UGA-3000? Assume that there are no taxes.

Answer 1

equivalent annual annuity (EAA) = (r * NPV)/(1 - (1+r)^(-n))

Where:

r – Project discount rate (WACC)

NPV – The net present value of project cash flows

n – project life (in years)

For UGA-3000

r = 9.54%

	UGA-3000
Year	Cashflow	PV of cashflow
0	-1,23,395.00	-1,23,395.00
1	28,017.00	25,576.96
2	28,017.00	23,349.42
3	28,017.00	21,315.89
4	28,017.00	19,459.46
5	28,017.00	17,764.70
6	28,017.00	16,217.55
7	28,017.00	14,805.14
8	28,017.00	13,515.74
9	28,017.00	12,338.63
	NPV	40,948.48

EAA = (9.54% * 40,948.48 )/ (1 - 1.0954^-9)

= $6,980.83

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