Lexington Power Systems is comparing four machines, each of which uses a differe

Question

Lexington Power Systems is comparing four machines, each of which uses a different technology, to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and whichever type is chosen will be replaced when worn out. Which one of the following computational methods should Lexington use as the basis for its decision?

internal rate of return

operating cash flow

equivalent annual cost

depreciation tax shield

bottom-up operating cash flow

internal rate of return

operating cash flow

equivalent annual cost

depreciation tax shield

bottom-up operating cash flow

Explanation / Answer

The correct answer should be c. Equivalent annual cost

Equivalent Annual Cost (EAC) is most useful as a decision-making tool in capital budgeting, when comparing investment projects of unequal but repeating lifespans, i.e where a replacement cycle is involved.

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