You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $100,000 to purchase and which will have OCF of −$7,000 annually throughout the machine's expected life of three years; and machine B, which will cost $125,000 to purchase and which will have OCF of −$2,600 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 15 percent, using EAC which one should you choose?
A) Machine A
B) Machine B
C) All of these choices are correct.
D) Neither machine A nor B

Question

Quizplus · Accepted Answer

To determine the least expensive machine using the Equivalent Annual Cost (EAC) method, we calculate the EAC for both machines. The EAC is the annual cost of owning, operating, and maintaining an asset over its entire lifecycle, discounted back to present value terms. Given the cost of capital is 15%, we use this as the discount rate.For Machine A:- Initial cost = $100,000- Annual OCF = -$7,000- Life = 3 years- Discount rate = 15%EAC for Machine A = Initial cost / PVIFA (15%, 3 years) + Annual OCFPVIFA (Present Value Interest Factor of Annuity) for 15% and 3 years ≈ 2.283EAC_A ≈ $100,000 / 2.283 - $7,000 ≈ $43,800 - $7,000 ≈ $36,800For Machine B:- Initial cost = $125,000- Annual OCF = -$2,600- Life = 4 years- Discount rate = 15%EAC for Machine B = Initial cost / PVIFA (15%, 4 years) + Annual OCFPVIFA for 15% and 4 years ≈ 2.855EAC_B ≈ $125,000 / 2.855 - $2,600 ≈ $43,780 - $2,600 ≈ $41,180Comparing the EACs, Machine B, despite its higher initial cost and longer life, has a lower Equivalent Annual Cost when considering the cost of capital and the operational cash flows. Therefore, Machine B is the less expensive option in the long run.

You Are Trying to Pick the Least-Expensive Machine for Your