Nemo Haulers is considering whether to purchase a new mini tractor for moving furniture within its warehouse. Nemo calculates that its current mini tractor generates $3,100 of cash flow per year. A new mini tractor would cost $3,000 and would provide cash flow of $4,000 per year for five years. What is the equivalent annual cash flow for the new mini tractor (round to the nearest dollar), and should Nemo purchase the new tractor? Assume the cost of capital for Nemo is 10 percent.

$3,208.62

Explanation:

initial investment for a new mini tractor -$3,000

5 yearly cash flows of $4,000

discount rate 10%

first we must find the present value of the cash flows:

$4,000 x 3.7908 (PV annuity factor, 10%, 5 periods) = $15,163.20

to determine the equivalent annual cash flow we can use the following formula:

EAC = (NPV x r) / [1 - (1 + r)⁻ⁿ]

NPV = $15,163.20 - $3,000 = $12,163.20

r = 10%

n = 5

EAC = ($12,163.20 x 0.1) / [1 - (1 + 0.1)⁻⁵] = $1,216.32 / 0.379 = $3,208.62

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