Question

9. You are trying to decide between two mobile phone carriers. Carrier A requires you to pay $200 for the phone and then monthly charges of $54 for 24 months. Carrier B wants you to pay $95 for the phone and monthly charges of $72 for 12 months. Assume you will keep replacing the phone after your contract expires. Your cost of capital is 3.5%. Based on cost alone, who carrier should you choose.

Answer 1

Answer:

Carrier A

Explanation:

In order to decide the carrier on cost alone, we will use the Equivalent Annual Annuity method to calculate the best choice on cost alone. As shown below:

Equivalent Annual Annuity (EAA) - Carrier A

Total Present Value = -$200 + {-$54(PVIFA 0.2917%, 24 Periods)}

Total Present Value = -$200 + {-$54 x 26}

Total Present Value = -$200 + -1,404

Total Present Value = -$1,604

Equivalent Annual Annuity (EAA) = Total Present Value / (PVIFA 0.3333%, 24 Periods)

Equivalent Annual Annuity (EAA) = -$1,604 / 26

Equivalent Annual Annuity (EAA) = -$67

"Equivalent Annual Annuity (EAA) - Carrier A = -$67"

Equivalent Annual Annuity (EAA) - Carrier B

Total Present Value= -$95 + {-$72(PVIFA 0.3333%, 12 Periods)}

Total Present Value = -$95 + -$72 x 13

Total Present Value = -$95 - 936

Total Present Value = -$1,031

Equivalent Annual Annuity (EAA) = Total Present Value / (PVIFA 0.3333%, 12 Periods)

Equivalent Annual Annuity (EAA) = -$1,031 / 13

Equivalent Annual Annuity (EAA) = -$79

"Equivalent Annual Annuity (EAA) - Carrier B = -$79"

The "Carrier-A" should be selected, Since the Equivalent Annual Annuity (EAA) of Carrier-A (-$67) is higher than the Equivalent Annual Annuity (EAA) of Carrier-B (-$79).

Note: All figures in the calculation are rounded off to whole number