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Unformatted text preview: Equivalent Annual Cost Machine A costs $100 to buy and $10 per year to operate. It wears out and must be replaced every two years. Machine B costs $140 to buy and $8 per year to operate. It lasts for three years and must then be replaced. Ignoring taxes, which one should we choose if we use a 10 percent discount rate? Step 1: Compute PV Machine A: PV= 100 + (10/1.1) + (10/1.1 2 ) = $117.36 Machine B: PV= 140 + (8/1.1) + (8/1.1 2 ) + (8/1.1 3 ) = $159.89 Step 2: Calculate Annuity Factor (Chp 6) of each Machine Machine 1: (1 – (1/1.1 2 )) / .1 = 1.7355 Machine 2: (1 – (1/1.1 3 ) / .1 = 2.4869 Step 3: Calculate EAC Machine 1: 117.36 * 1.7355 = 67.26 Machine 2: 159.89 * 2.4869 = 64.29 Conclusion Machine B is more effective Quiz Problem Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straightline depreciation to a zero book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $26,300, and a 4year life. its equipment....
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This note was uploaded on 07/31/2011 for the course FIN 550 taught by Professor Rajneeshsharma during the Summer '11 term at Saint Joseph's University.
 Summer '11
 RajneeshSharma

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