You are trying to choose between two different types of machinery. Machinery A w

Question

You are trying to choose between two different types of machinery. Machinery A will cost you 11 thousand dollars to acquire. Its maintenance costs are expected to be 2 thousand dollars at the end of year 1, 2 thousand dollars at the end of year 2, 1 thousand dollars at the end of year 3. It will become obsolete at the end of third year.

Machinery B will cost you 18 thousand dollars to acquire. Its maintenance costs are expected to be 2 thousand dollars at the end of year 1, 1 thousand dollars at the end of year 2. It will become obsolete at the end of second year.

Your cost of capital is 8% for both types of machinery. You will choose the one with the smaller Equivalent Annual Annuity (EAA). How much higher is the EAA of equipment A than the EAA of equipment B. (Round your answer to the nearest dollar and enter a negative number if the EAA of A is smaller than that of B.)

Please help. clueless on this one.

Explanation / Answer

The EAA method is an alternative to the Replacement Chain method, for use in evaluating projects with unequal lives. The EAA model derives a dollar value of the project that represents the same financial value of the NPV, except that the dollar value of the EAA is for payments or benefits that are equally spread over the life of the project (an annuity). The annual annuity can be compared between projects, and the project with the highest annuity should be chosen over lower annuity. Here you have posted only the expenses in the two projects but no revenue is shown. Hence I can't work out EAA. But EAA formula will give you clue. EAA= (Ks*NPV)/((1-(1+Ks)^(-n))) where n is Project duration

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