You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $50,000 to purchase and which will have OCF of −$3,500 annually throughout the machine's expected life of three years; and machine B, which will cost $75,000 to purchase and which will have OCF of −$4,900 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 14 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. It allows for a comparison of the costs of assets with different lifespans.For Machine A:- Initial cost = $50,000- Annual cash flow (OCF) = -$3,500- Life = 3 years- Cost of capital = 14%EAC for Machine A = Initial cost / PVIFA (14%, 3 years) + Annual OCFPVIFA (Present Value Interest Factor of Annuity) for 14% and 3 years ≈ 2.3216EAC_A = $50,000 / 2.3216 - $3,500 ≈ $21,529.41 - $3,500 ≈ $18,029.41For Machine B:- Initial cost = $75,000- Annual cash flow (OCF) = -$4,900- Life = 4 years- Cost of capital = 14%EAC for Machine B = Initial cost / PVIFA (14%, 4 years) + Annual OCFPVIFA for 14% and 4 years ≈ 2.9137EAC_B = $75,000 / 2.9137 - $4,900 ≈ $25,734.73 - $4,900 ≈ $20,834.73Comparing the EACs, Machine A has a lower Equivalent Annual Cost than Machine B, making it the less expensive option over its life when considering the cost of capital.

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