Info

—•—Equivalent Annuity - Used Car —■ Equivalent Annuity - New Car

The break-even occurs at roughly 5500 miles; if there is a reasonable chance that the mileage driven will exceed this break-even, the new car becomes the better option.

Illustration 6.5: Using Equivalent Annuities as a General Approach for Multiple Projects The equivalent annuity approach can be used to compare multiple projects with different lifetimes. For instance, assume that Disney is considering three storage alternatives for its retailing division:

Alternative Initial Investment Annual Cost Project Life

Build own storage system $ 10 million $ 0.5 million Infinite

Rent storage system $ 2 million $ 1.5 million 12 years

Use third-party storage ----------$ 2.0 million 1 year

These projects have different lives; the equivalent annual costs have to be computed for the comparison. If the correct cost of capital for the retail business is 12.5%, the equivalent annual costs can be computed as follows:

Alternative Net Present Value Equivalent Annual Cost

Build own storage system $ 14.00 million $ 1.75 million Rent storage system $ 11.08 million $ 1.83 million

Use third-party storage $ 2.00 million $ 2.00 million

Based on the equivalent annual costs, Disney should build its own storage system, even though the initial costs are the highest for this option.

Money Mogul

Money Mogul

Get All The Support And Guidance You Need To Be A Success At Being A Money Mogul. This Book Is One Of The Most Valuable Resources In The World When It Comes To How to Maintain the Pledge to Fix Your Finances from Your New Year’s Resolution.

Get My Free Ebook


Post a comment