You are given the following information about equipment required for your busine

Question

You are given the following information about equipment required for your business. Assume that the equipment will be replaced as it wears out and that straight-line depreciation to zero is used for each. The required return is 15%. Ignore taxes.

Machine A has an initial cost of $200,000, an operating cost per year of $15,000, and an expected life of 8 years. Machine B has an initial cost of $300,000, an operating cost per year of $17,500, and an expected life of 10 years.

What is the EAC of Machine A?

1. -$301,664
2. -$201,676
3. -$48,163
4. -$59,570
5. -$22,427

Explanation / Answer

Period Cash flows PV Factor at 15% Present Value of Cash Outflows 0 $200,000 1 $200,000 1 $15,000 0.8696 $13,044 2 $15,000 0.7561 $11,342 3 $15,000 0.6575 $9,863 4 $15,000 0.5718 $8,577 5 $15,000 0.4972 $7,458 6 $15,000 0.4323 $6,485 7 $15,000 0.3759 $5,639 8 $15,000 0.3269 $4,904 Present Value of Cash Outflows $267,310 Annual Cost of Owning an Asset over the its entire life = [(Asset Price * Discount Rate) / 1- (1+Discount Rate) –Number of Periods Annual Cost = [($267,310 * 0.15) / 1- (1+15)-8] Annual Cost = [$40,096.50 / (1-0.326901774)] EAC = -$59,570

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