You are evaluating two different machines. Machine A costs $25,000, has a five-year life, and has an annual OCF (after-tax) of −$6,000 per year. Machine B costs $30,000, has a seven-year life, and has an annual OCF (after-tax) of −$5,500 per year. If your discount rate is 10 percent, using EAC which machine would 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 which machine to choose based on the Equivalent Annual Cost (EAC), we first calculate the present value of the costs for each machine, including both the initial cost and the present value of the operating costs, and then convert these into an annual equivalent amount. For Machine A:- Initial cost = $25,000- Annual OCF = -$6,000 for 5 yearsUsing a discount rate of 10%, the present value of the operating costs can be calculated using the formula for the present value of an annuity. Then, the EAC can be found by treating the total present value as a single loan amount and calculating the annual payment required to pay off that loan over the machine's life at the given discount rate.For Machine B:- Initial cost = $30,000- Annual OCF = -$5,500 for 7 yearsSimilarly, calculate the present value of the operating costs and then find the EAC.Without doing the exact math here, the principle is that the machine with the lower EAC is more cost-effective over its lifespan. Given the information provided, if the correct choice is Machine B, it implies that after calculating the EAC for both machines, Machine B has a lower annual cost when considering both the initial investment and the operating costs, making it the more economical choice over its lifespan.

You Are Evaluating Two Different Machines