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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

EQUIVALENT ANNUAL ANNUITY Faleye Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment (System A) for $21,000, 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?

Summary Introduction

To Determine: The EAA of System A and System B and the suitable System that should be chosen.

Introduction: EAA or Equivalent annual annuity is a methodology utilized in capital budgeting to pick between mutually exclusive projects with uneven useful lives. The project with greater equivalent annual annuity is chosen.

Explanation

Determine the equivalent annual annuity for System A

Using a excel spreadsheet and excel function =PMT, the equivalent annual annuity for System A is determined as $1,178.24.

Excel Spreadsheet:

Excel Workings:

Therefore the equivalent annual annuity for System A is $1,178.25...

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