Suppose that your firm is trying to decide between two machines that will do the
ID: 1172054 • Letter: S
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)
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.
Lower the cost, better it is
Machine A requires lesser outflow each year
Machine A:
Net Outflow = 50,000+5000*PVAF(10%,10 years) – 10,000*PVF(10%, 10 years)
= 50,000 + 5000*6.145-10,000*0.386
=76,865
EAC = Net Cash Outflow/PVAF(10%, 10 years) = 12,509
Machine B :
Net Outflow = 60,000+6000*PVAF(10%,7 years) – 5,000*PVF(10%, 7 years)
= 60,000 + 6000*4.868-5,000*0.513
=86,643
EAC = 17,798
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