E he cost of capital Comparing projects with unequal economic life. Rollon Inc.
ID: 2617171 • Letter: E
Question
E he cost of capital Comparing projects with unequal economic life. Rollon Inc. is comparing the operating costs of two types of equipm standard model costs $50,000 and will have a useful life of four years. Oper 10. The at- ent. ing costs are expected to be $4,000 per year. The superior model costs $90,000 and will have a useful life of six years. Its operating costs are expected to be $2,500 per year. Both models will be able to operate at the same level of out- put and quality and generate the same cash earnings. Rollon's cost of capital is percent a. Compute the present values of the cash costs over the useful life of each model. b. Can the two present values be compared? If not, why not? c. What is the annuity-equivalent cost of each model? d. Which model should the company purchase? ExplainExplanation / Answer
a) Present value of the cash costs over the useful life of standard model and superior model is $13,248 and $11,558 respectively.
b) Since the useful life of each model is different we can not compare these two models. So need to calculate Equivalent Annual Cost(EAC).
c) Equivalent Annual Cost of standard model and superior model is $19,097 and $21,968 respectively.
d) The company should purchase standard model since it has lower Equivalent Annual Cost.
Standard Model Superior Model a Purchase Cost ($) 50,000 90,000 b Life of machines (years) 4 6 c Running cost per year ($) 4,000 2,500 d PVAF (based on life and 8% discount factor) 3.312 4.623 e Present Value of Running cost of machine (c*d) 13,248 11,558 f Cash outflow of machines (a+e) 63,248 101,558 g Equivalent Annual Cost (f/d) 19,097 21,968Related Questions
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