You are considering the purchase of one of two machines required in your production process. Machine A has a life of two years. Machine A costs $50 initially and then $70 per year in maintenance. Machine B has an initial cost of $90. It requires $40 in maintenance for each year of its 3 year life. Either machine must be replaced at the end of its life. Which is the better machine for the firm? The discount rate is 15% and the tax rate is zero.
A) Machine A as EAC for Machine A is $100.76
B) Machine B as EAC for Machine B is $79.42
C) Machine A as PV of costs for Machine A is $163.80
D) Machine B as PV of costs for Machine B is $181.33

Question

Quizplus · Accepted Answer

To compare the two machines, we need to calculate their equivalent annual cost (EAC) and present value of costs (PV). 
For Machine A, EAC = (50 + 70PVIFA(15%,2)) = $100.76 and PV of costs = 50 + 70PVIF(15%,1) + 70PVIF(15%,2) = $163.80
For Machine B, EAC = (90 + 40PVIFA(15%,3)) = $79.42 and PV of costs = 90 + 40PVIF(15%,1) + 40PVIF(15%,2) + 40PVIF(15%,3) = $181.33
Since Machine B has a lower EAC and only slightly higher PV of costs, it is the better choice for the firm.

You Are Considering the Purchase of One of Two Machines