Cepeda Corporation requires a computer system for the next ten years, and is in the process of choosing among two mutually exclusive alternatives. System A costs $50,000 today, and will produce positive net cash flows of $12,000 a year for the next ten years (t = 1 through t = 10). System B costs $30,000 today and will produce positive net cash flows of $11,000 a year for the next five years. After five years, System B can be replaced under the same terms. The company's cost of capital is 10 percent. What is the equivalent annual annuity (EAA) of the best system?
Click on the arrows to vote for the correct answer
A. B. C. D. E.B
First find the NPV's of each system over its initial life.
System A: CF(0) = -50,000; CF(1-10)= 12,000; I = 10; solve for NPV = $23,734.81. System B: CF(0) = -30,000; CF(1-5)= 11,000; I = 10, solve for NPV =
$11,698.65. Second, find the value of the EAA of each system.
System A: N = 10; I = 10; PV = -23,734.81; FV = 0; solve for PMT = EAA = $3,862.73. System B: N = 5; I = 10; PV = -11,698.65; FV = 0; solve for PMT = EAA =
$3,086.07. Given System A has a higher EAA, it is the better of the two systems.