You are considering the purchase of one of two machines used in your manufacturi

Question

You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $85 initially, and then $130 per year in maintenance costs. Machine B costs $155 initially, has a life of three years, and requires $105 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine.

The discount rate is 11 percent and the tax rate is zero. Calculate the EAC. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $85 initially, and then $130 per year in maintenance costs. Machine B costs $155 initially, has a life of three years, and requires $105 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine.

Explanation / Answer

The NPV of one Machine A will be:

NPV = - 85/ (1.11)0 - 130/ (1.11)1 -  130/ (1.11)2

NPV = -307.63

Treating this as the present value of a 2-period annuity, setting i to 11%, and solving for payment will yield a payment of -$179.63, which is Machine A’s EAC

EAC of Machine A = -$179.63

The NPV of one Machine B will be:

NPV = - 155/ (1.11)0 - 105/ (1.11)1 -  105/ (1.11)2 -  105/ (1.11)3

NPV = -411.59

Treating this as the present value of a 3-period annuity, setting i to 11%, and solving for payment will yield a payment of -$168.43, which is Machine B’s EAC

EAC of Machine A = -$168.43

Based on the EACs, we should choose Machine B.

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