You are planning to buy snow removal equipment - (a sure way to make money in NY

Question

You are planning to buy snow removal equipment - (a sure way to make money in NY in April!). The machine you need costs $55,000 and has operating and maintenance costs that start at $15,000 the first year and increase by $2,000 per year each year thereafter. Assume that the salvage value at the end of 5 years is $2,000 and interest rate is 12%. What is the equivalent annual cost (i.e. annual worth) of owning and operating the machine?

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Explanation / Answer

Solution:-

As the NPV of cost of -$120731 will give the benefit of ownership for 5 years, we divide by the 5 year annuity factor at the 12% cost of capital to get the EAC.

EAC = NPV / Annuity factor of last year.

= -120730.82 / 1.56742

EAC = -77024.85

NPV Time 0 1 2 3 4 5 Initial cost -55,000 Maintenance -15000 -17,000 -19,000 -21,000 -23,000 Residual value 2000 Net cash flows -55,000 -15,000 -17,000 -19,000 -21,000 -21,000 12% Discount factors 1 0.8929 0.7972 0.7118 0.6355 0.5674 Present values -55,000 -13,393 -13,552 -13,524 -13,346 -11,916 Net present value -120,731

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