Question

FIN 302 Summer 2020 Sa Homework: Chapter 11 Homework Score: 0 of 1 pt 3 of 9 (2 complete) HW Score: 18.8%, 1.69 of 9 P11-4 (similar to) Question Help (Related to Checkpoint 11.2) (Calculating EAC) Barry Boswell is a financial analyst for Dossman Metal Works, Inc. and he is analyzing two alternative configurations for the firm's new plasma cutter shop. The two alternatives, denoted A and B below, will perform the same task, but alternative A will cost $90,000 to purchase, while alternative B will cost only $60,000. Moreover, the two alternatives will have very different cash flows and useful lives. The after-tax costs for the two projects are as follows: a. Calculate each project's EAC, given a discount rate of 10 percent. b. Which of the alternatives do you think Barry should select? Why? a. Alternative A's EAC at a discount rate of 10% is $. (Round to the nearest cent.)

Answer 1

To calculate the EAC we have to find out the present value of the cash outflows and the equate it with present value of annuity formula

Alternative A :

Years	Cashflow - (i)	Discounting Factor @ 10%(ii = 1/ (1+r)^n)	Present Value ( C= i*ii)
0	-90000	1	-90000.00
1	-17000	0.909090909	-15454.55
2	-17000	0.826446281	-14049.59
3	-17000	0.751314801	-12772.35
4	-17000	0.683013455	-11611.23
5	-17000	0.620921323	-10555.66
6	-17000	0.56447393	-9596.06
7	-17000	0.513158118	-8723.69
Total of Present value of Cash Outflows	-172763.12

172763.12 = EAC * { 1- ( 1+ r)^-n } / r

172763.12 = EAC * ( 1- 1.1^-7)/ 0.10

EAC of Alternative A= $35,486.49

Alternative B :

Years	Cashflow - (i)	Discounting Factor @ 10%(ii = 1/ (1+r)^n)	Present Value ( C= i*ii)
0	-60000	1	-60000.00
1	-7000	0.909090909	-6363.64
2	-7000	0.826446281	-5785.12
3	-7000	0.751314801	-5259.20
Total of Present value of Cash Outflows	-77407.96

77407.96 = EAC*( 1- 1.1^-3 ) / 0.10

EAC of Alternative B= $31,126.90

We should select Alternative B as the same as EAC is lesser in Alternative B.