Question

Faleye Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment (System A) for $23,000, which will generate cash flows of $6,000 at the end of each of the next 6 years. Alternatively, the company can spend $11,000 for equipment that can be used for 3 years and will generate cash flows of $6,000 at the end of each year (System B). If the company’s WACC is 10% and both “projects” can be repeated indefinitely, which system should be chosen, and what is its EAA? Do not round intermediate calculations. Round your answer to the nearest cent.

Choose Project -Select-(A or B) , whose EAA = ?$  

Answer 1

System A
Discount rate	0.1
Year	0	1	2	3	4	5	6
Cash flow stream	-23000	6000	6000	6000	6000	6000	6000
Discounting factor	1	1.1	1.21	1.331	1.4641	1.61051	1.771561
Discounted cash flows project	-23000	5454.545	4958.678	4507.889	4098.0807	3725.528	3386.844
NPV = Sum of discounted cash flows
NPV System A =	3131.56
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Equvalent annuity(EAA)=	719.03
Required rate =	0.1
Year	0	1	2	3	4	5	6
Cash flow stream	0	719.0293	719.0293	719.0293	719.02929	719.0293	719.0293
Discounting factor	1	1.1	1.21	1.331	1.4641	1.61051	1.771561
Discounted cash flows project	0	653.663	594.2391	540.2173	491.10668	446.4606	405.8733
Sum of discounted future cashflows =	3131.56
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
System B
Discount rate	0.1
Year	0	1	2	3
Cash flow stream	-11000	6000	6000	6000
Discounting factor	1	1.1	1.21	1.331
Discounted cash flows project	-11000	5454.545	4958.678	4507.889
NPV = Sum of discounted cash flows
NPV System B =	3921.11
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Equvalent annuity(EAA)=	1576.74
Required rate =	0.1
Year	0	1	2	3
Cash flow stream	0	1576.736	1576.736	1576.736
Discounting factor	1	1.1	1.21	1.331
Discounted cash flows project	0	1433.397	1303.088	1184.625
Sum of discounted future cashflows =	3921.11
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Choose System B as it has higher EAA