The Fairmont Hotel in San Francisco needs to replace its air conditioning system

Question

The Fairmont Hotel in San Francisco needs to replace its air conditioning system. There are two alternatives, both of which can do the job equally well:

The relevant discount rate is 10% and the marginal tax rate is 35%.

What is the equivalent annual cost for AC 1 (in absolute terms)?
What is the operating cash flow for AC 2 per year?
What is the equivalent annual cost for AC 2 (in absolute terms)?

Machine name AC 1 AC 2 Purchase price $40,000 $60,000 Operating cost (end of each year) $17,000 $8,000 Useful life (years) 4 6 Straight line depreciation to zero over (years) 4 6 Salvage value at end of useful life $0 $0

Explanation / Answer

Now the answers

EAC of AC1 = 26122.27

Operating Cash flow of AC2 per year = 4500

EAC of AC2 = 18280.43

Machine name AC1 AC2 Purchase price 40000 60000 Operating cost per year (A) 17000 8000 Depreciation per year 10000 (40000/4) 10000(60000/6) Tax savings on Depreciation (B) 3500 (10000x35%) 3500(10000x35%) Cash outflow (A) -( B) 13500 4500 Present value annuity factor @10% , for 4 yar and 6 year 3.169 4.354 Present value of Cash flow 42781.5 (13500x3.169) 19593 Total Present value of cash outflow 82781.5 (40000+42781.5) 79593 (60000+19593) Equalent Annual cost 26122.27 (82781.5/3.169) 18280.43

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