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You are evaluating two different computer servers for the business you work for. Server X costs...

You are evaluating two different computer servers for the business you work for. Server X costs $450,000, has a three-year life and costs $50 000 per year to operate. Server B costs $650,000, has a five-year life, and costs $40,000 per year to operate. The relevant discount rate is 8 per cent and corresponds with the 8% before–tax cost of debt. Ignoring depreciation and taxes, compute the Annual Equivalent Cost (AEC) for both servers. Which one would be preferred?

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Answer #1

Sotution:

Present Value of Cash outflows of Server X = $450,000 + $50,000* Cumulative PV Factor @8% for 3 years

= $450,000 + $50,000 *2.577097 = $578,854.8494

AEC of server X = Present Vaue of Cash Outflows / Cumulative PV Factor @8% for 3 years

=$578,854.8494 / 2.577097 = $224,615.08

Present Value of Cash outflows of Server B.= $650,000 + $40,000* Cumulative PV Factor @8% for 5 years

=$650,000 + $40,000*3.992710 = $809,708.4015

AEC of server B = Present Vaue of Cash Outflows / Cumulative PV Factor @8% for 5 years

= $809,708.4015 /3.992710 = $202,796.70

Server B should be preferred because its AEC is lesser than that of Server X.

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