You are trying to pick the least-expensive car for your new delivery service. Yo

Question

You are trying to pick the least-expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $18,000 to purchase and which will have OCF of –$2,000 annually throughout the vehicle’s expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $27,000 to purchase and which will have OCF of –$1,050 annually throughout that vehicle’s expected 4-year life. Both cars will be worthless at the end of their life. You intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future. If the business has a cost of capital of 13 percent, calculate the EAC.

Explanation / Answer

EAC i.e.Equivalent Annual Cost = [Initial cost / Annuity factor] + Annual Maintenance cost Calculation of Annuity Factor Annuity Factor = [1-{1/(1+r)^t}] / r r = discount rate t = no.of years Annuity Factor for Scion xA = [1-{1/(1+r)^t}] / r = [1-{1/(1+0.13)^3}] / 0.13 = 2.36 Annuity Factor for Toyoto prius = [1-{1/(1+r)^t}] / r = [1-{1/(1+0.13)^4}] / 0.13 = 2.97 Calculation of EAC EAC of Scion Xa = [$18000/2.36] + $2000 = $9623.40 EAC of Toyoto Prius = [$27000/2.97] + $1050 = $10127.24

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