Question 3: (15 points). (Related to Checkpoint 11.2) (Equivalent annual cost ca

Question

Question 3: (15 points). (Related to Checkpoint 11.2) (Equivalent annual cost calculation) Barry Boswell is a financial analyst for Dossman Metal Works, Inc. and he is analyzing two alternative configurations for the firm's new plasma cutter shop. The two alternatives that are denoted A and B below perform the same task and although they each cost to purchase and install they offer very different cash flows. Alternative A has a useful life of 7 years whereas Alternative B will only last for 3 years. The after-tax cash flows from the two projects are as follows:

Year Alternative A Alternative B

0 (90,000) (95,000)   

1 (19,000) (5,000)

2 (19,000) (5,000)  

3 (19,000) (5,000)

4 (19,000)

5 (19,000)

6    (19,000)

7 (19,000)

a. Calculate each project's equivalent annual cost (EAC) given a discount rate of 10 percent. (Round to the nearest cent.)

a. Alternative A's equivalent annual cost (EAC) at a discount rate of 10% is:

$

b. Alternative B's equivalent annual cost (EAC) at a discount rate of 10% is

$

b. Which of the alternatives do you think Barry should select? Why? (Select the best choice below.)

a. This cannot be determined from the information provided.

b. Alternative B should be selected because its equivalent annual cost is less per year than the annual equivalent cost for Alternative A.

c. Alternative A should be selected because its equivalent annual cost is less per year than the annual equivalent cost for Alternative B.

d. Alternative A should be selected because it has the highest NPV.

a. Alternative A's equivalent annual cost (EAC) at a discount rate of 10% is:

$

b. Alternative B's equivalent annual cost (EAC) at a discount rate of 10% is

$

Explanation / Answer

(a)

EAC, Alt A ($) = 90,000 x A/P(10%, 7)** + 19,000 = 90,000 x 0.21 + 19,000 = 18,900 + 19,000 = 37,900

EAC, Alt B ($) = 95,000 x A/P(10%, 3)** + 5,000 = 95,000 x 0.4 + 5,000 = 38,000 + 5,000 = 43,000

(b) Correct option (c).

Since Alt A has lower EAC per year than Alt B, A should be chosen.

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