A company wishes to select the best of three possible computers, each expected t

Question

A company wishes to select the best of three possible computers, each expected to meet the University's growing need for computational and storage capacity. The three computers— A, B, and C—are equally risky. Computer A will require an initial outlay of $50,000 while computer B will cost $35,000 and computer C costs $60,000. The University plans to use a 12% cost of capital to evaluate each of them. The initial outlay and annual cash flows over the life of each computer are shown in the following table:

                  Year                Computer A            Computer B            Computer C

                   1                      $7,000                     $5,500                  $18,000

                   2                        7,000                     12,000                     18,000

                   3                        7,000                     16,000                     18,000

                   4                        7,000                     23,000                     18,000

                   5                        7,000                         -                           18,000

                   6                        7,000                         -                                -

A. Calculate the NPV for each computer over its life. Rank the computers in descending order based on their NPVs.

B. Use the equivalent annual cost approach to evaluate and rank the computers in descending order based on the EAC criterion.

C. Compare and contrast your findings in parts (a) and (b). Which computer would you recommend that the University acquire? Why?

Explanation / Answer

Ans A

Ans B

Ans c

Recommende computer is A since A gives the Equated anuual Cost among all three alternatives, though under the normal NPV method the computer B give the lease cash outflows. Equated Annual cost method is the preferrable one where the investment alternatives under consideration are having unequal project lives.

Year Computer A Computer B Computer C DF @ 12% Computer A Computer B Computer C Cash Flow PVDF PV of Cash Flow 0 50000 35000 60000           1.00 50,000.00 35,000.00      60,000.00 1 7000 5000 18000           0.89     6,250.00     4,464.29      16,071.43 2 7000 12000 18000           0.80     5,580.36     9,566.33      14,349.49 3 7000 16000 18000           0.71     4,982.46 11,388.48      12,812.04 4 7000 23000 18000           0.64     4,448.63 14,616.92      11,439.33 5 7000 18000           0.57     3,971.99                  -        10,213.68 6 7000           0.51     3,546.42                  -                        -   78,779.85 75,036.01 1,24,885.97

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