Suppose a firm is forced to choose between two machines, A and B. The two machin
ID: 2738248 • Letter: S
Question
Suppose a firm is forced to choose between two machines, A and B. The two machines are designed differently but have identical capacity and do exactly the same job. Machine A costs $15,000 and will last three years. It costs $5,000 per year to run. Machine B is an economy model costing only $10,000, but it will last only two years and costs $6,000 per year to run. The cost of capital for either project is 6%. Because the two machines produce the same product, the only way to choose between them is on the basis of cost. Using the equivalent annual cost approach, determine which machine the company should buy.
Explanation / Answer
EAC for Machine A = $15,000 / [1 - (1 + 6%)-3] / 6%} + $5,000
= $10,611.65
EAC for Machine B = $10,000 / [1 - (1 + 6%)-2] / 6%} + $6,000
= $11,454.37
Machine A should be bought due to lower EAC.
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