Suppose that your firm is trying to decide between two machines that will do the

Question

Suppose that your firm is trying to decide between two machines that will do the same job. Machine A costs $50,000, will last for ten years and will require operating costs of $5,000 per year. At the end of ten years it will be scrapped for $10,000. Machine B costs $60,000, will last for seven years and will require operating costs of $6,000 per year. At the end of seven years it will be scrapped for $5,000. Which is a better machine and why? (discount rate is 10 percent) A.  A is a better machine because it has a larger NPV. B.  A is a better machine because it has a smaller Equivalent Annual Cost. C.  B is a better machine because it has a larger NPV. D.  B is a better machine because it has a smaller Equivalent Annual Cost. E.  B is a better machine because it has a larger Equivalent Annual Cost. Suppose that your firm is trying to decide between two machines that will do the same job. Machine A costs $50,000, will last for ten years and will require operating costs of $5,000 per year. At the end of ten years it will be scrapped for $10,000. Machine B costs $60,000, will last for seven years and will require operating costs of $6,000 per year. At the end of seven years it will be scrapped for $5,000. Which is a better machine and why? (discount rate is 10 percent) A.  A is a better machine because it has a larger NPV. B.  A is a better machine because it has a smaller Equivalent Annual Cost. C.  B is a better machine because it has a larger NPV. D.  B is a better machine because it has a smaller Equivalent Annual Cost. E.  B is a better machine because it has a larger Equivalent Annual Cost.

Explanation / Answer

B.  A is a better machine because it has a smaller Equivalent Annual Cost.

Machine A 0 1 2 3 4 5 6 7 8 9 10 Initial Invetsment -50000 Operating Costs -5000 -5000 -5000 -5000 -5000 -5000 -5000 -5000 -5000 -5000 Scrape Value 10000 Total Cash Flow -50000 -5000 -5000 -5000 -5000 -5000 -5000 -5000 -5000 -5000 5000 NPV = -76867.40 Equivalent Annual Cost =
r * NPV/[(1 -(1+r)^-n] -12509.82 Machinne B 0 1 2 3 4 5 6 7 Initial Invetsment -60000 Operating Costs -6000 -6000 -6000 -6000 -6000 -6000 -6000 Scrape Value 5000 Total Cash Flow -60000 -6000 -6000 -6000 -6000 -6000 -6000 -1000 NPV = -86644.72 Equivalent Annual Cost =
r * NPV/[(1 -(1+r)^-n] -17797.30248

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