Walker & Campsey wants to invest in a new computer system, and management has na

Question

Walker & Campsey wants to invest in a new computer system, and management has narrowed the choice to Systems A and B.
System A requires an up-front cost of $100,000, after which it generates positive after-tax cash flows of $60,000 at the end of each of the next 2 years. The system could be replaced every 2 years, and the cash inflows and outflows would remain the same.
System B also requires an up-front cost of $100,000, after which it would generate positive after-tax cash flows of $48,000 at the end of each of the next 3 years. System B can be replaced every 3 years, but each time the system is replaced, both the cash outflows and cash inflows would increase by 10%.
The company needs a computer system for 6 years, after which the current owners plan to retire and liquidate the firm. The company's cost of capital is 14%. What is the NPV (on a 6-year extended basis) of the system that adds the most value? (Please show work)

Using the information from problem above on Walker & Campsey, what is the equivalent annual annuity (EAA) for System A? (Please show work)

Explanation / Answer

NPV of SYSTEM A = -100000 + 60000/1.14 + 60000/1.14^2 - 100000/1.14^2 + 60000/1.14^3+ 60000/1.14^4 - 100000/1.14^4 + 60000/1.14^5+ 60000/1.14^6

NPV of SYSTEM A = - $ 2834.73

NPV of SYSTEM B = -100000 + 48000/1.14 + 48000/1.14^2+ 48000/1.14^3 - 100000/1.14^3 + 48000/1.14^4+ 48000/1.14^5 + 48000/1.14^6

NPV of SYSTEM B = $ 19,158.89

SYSTEM A

Equivalent annual annuity (EAA) for System A = NPV/PVIFA(14%,6)

Equivalent annual annuity (EAA) for System A = - 2834.73/3.8887

Equivalent annual annuity (EAA) for System A = - $ 728.97

SYSTEM B

Equivalent annual annuity (EAA) for System B = NPV/PVIFA(14%,6)

Equivalent annual annuity (EAA) for System B = 19,158.89/3.88867

Equivalent annual annuity (EAA) for System B = $ 4926.85

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