Answer Happy

XYZ Industries wants to invest in a new system and has narrowed
the choice down to System X and System Y. The company only wants to
invest in one system. System X has a life of four years and System
Y has life of eight years. The company’s cost of capital is
12%.
• System X requires an initial investment of $130,000 and then
generates positive after-tax cash flows of $50,000 at the end of
each of the next four years. At the end of four years, the expected
salvage value of the original system is zero. However, the firm
expects to be able to buy another System X at a cost of $150,000
that will generate after-tax cash flows of $60,000 a year for
another four years at which time the salvage value will again be
zero.
• System Y has an initial cash outflow of $140,000 and
subsequent year-end cash inflows are $35,000. After eight years,
management expects this system will have an after-tax salvage value
of $10,000.
A. Which system is preferable using the Equivalent Annual
Annuity approach?
B. Which system is preferable using the replacement
method?