Question

Lobo is a leading manufacturer of positronic brains, a key component in robots. The company is considering two alternative production methods. The costs and lives associated with each are: Year Method 1 Method 2 0 $ 6,700 $ 9,900 1 400 620 2 400 620 3 400 620 4 620 Suppose all the costs are before taxes and the tax rate is 39%. Both types of equipment would be depreciated at a CCA rate of 25% (Class 9), and would have no value after the project. What are the EACs in this case (r = 13%)? (Negative answers should be indicated by a minus sign. Do not round your intermediate calculations. Round the final answers to 2 decimal places. Omit $ sign in your response.) EAC Method 1 $ 5068.78 5068.78 Incorrect Method 2 $ 6665.65 6665.65 Incorrect Which is the preferred method? Method 1 Method 2

Answer 1

Method 1:

PV @ 13%(Costs) = -$6,700 – 400 x PVIFA (13%, 3) = -$7,644.46

Method 2:

PV @ 13%(Costs) = -$9,900 – 620 x PVIFA (13%, 4) = -$11,744.17

Difference= $4,099.71 in favour of Method 1

Without replacement: On this basis we would need to know whether the benefit of 1 more year’s use is sufficient to offset the additional cost of $4,099.71.

With replacement: Method 1: EAC = -7,644.46/PVIFA(13%,3) = -$3,237.60

Method 2: EAC = -11,744.17/PVIFA(13%,4) = -$3,948.32

On this basis, Method 2 is again more expensive.