You are starting a family pizza parlor and need to buy a motorcycle for delivery
ID: 2757822 • Letter: Y
Question
You are starting a family pizza parlor and need to buy a motorcycle for delivery orders. You have two models in mind. Model A costs $8,700 and is expected to run for 6 years; Model B is more expensive, with a price of $13,600, and has an expected life of 10 years. The annual maintenance costs are $500 for Model A and $620 for Model B. Assume that the opportunity cost of capital is 9 percent.
Calculate equivalent annual costs (EAC) of each models. (Do not round the discount factor. Round intermediate calculations and final answers to 2 decimal places, e.g. 15.25.)
Explanation / Answer
Model A
Year
Cash flow
PV Factor @ 9%
PV
0
(8,700)
1.0000
(8,700.00)
1
(500)
0.9174
(458.72)
2
(500)
0.8417
(420.84)
3
(500)
0.7722
(386.09)
4
(500)
0.7084
(354.21)
5
(500)
0.6499
(324.97)
6
(500)
0.5963
(298.13)
NPV
(10,942.96)
EAC=NPV/sum of Pv factor @ 9% for 5 years=10,942.96/ 4.4859 =2,439.
Model B
Year
Cash flow
PV Factor @ 9%
PV
0
(13,600)
1.0000
(13,600.00)
1
(620)
0.9174
(568.81)
2
(620)
0.8417
(521.84)
3
(620)
0.7722
(478.75)
4
(620)
0.7084
(439.22)
5
(620)
0.6499
(402.96)
6
(620)
0.5963
(369.69)
7
(620)
0.5470
(339.16)
8
(620)
0.5019
(311.16)
9
(620)
0.4604
(285.47)
10
(620)
0.4224
(261.89)
NPV
(17,578.95)
EAC=NPV/sum of Pv factor @ 9% for 10 years=17,578.95/ 6.4177 =2,739.15
We should buy Model A as it less cost
Model A
Year
Cash flow
PV Factor @ 9%
PV
0
(8,700)
1.0000
(8,700.00)
1
(500)
0.9174
(458.72)
2
(500)
0.8417
(420.84)
3
(500)
0.7722
(386.09)
4
(500)
0.7084
(354.21)
5
(500)
0.6499
(324.97)
6
(500)
0.5963
(298.13)
NPV
(10,942.96)
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