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

cognitive overload: having a lot on your mind impairs decision-making and tends to result in the simplest, but not necessarily best, option being selected.

empathy gaps: overlooking how you might feel in a different situation can result in unnecessary purchases, such as overbuying when shopping for food on an empty stomach.

optimism and overconfidence: wearing rose-tinted glasses and having unrealistic expectations about the future can affect money management and leave you unprepared for a change in circumstance.

instant gratification: seeking instant gratification drives impulsive spending and can undermine long-term planning and savings.

harmful habits: automatic or mindless behaviour can amplify a poor financial decision as it becomes a recurring event.

social norms: we are heavily influenced by the actions of others; while this can be in certain circumstances, it also contributes to the pressure to keep up with the joneses through conspicuous consumption.