Question

J&J Automotive is analyzing two machines to determine which one they should purchase. The company requires a 16% rate of return and the machinery belongs in a 30% CCA class. Machine A has a cost of $427,000, annual operating costs of $13,000, and a 4-year life. Machine B costs $390,000, has annual operating costs of $6,500, and has a 3-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should J&J purchase and why? Ignore taxes.

Multiple Choice

• B; because its EAC is $181,602.43

• B; because its EAC is $11,209.18 less than that of Machine A

• B; because its EAC is $12,408.23 less than that of Machine A

• A; because its EAC is $14,551.41 less than that of Machine B

• A; because its EAC is $162,408.19

Answer 1

Machine A:

NPV = Initial cost + PV of all operating costs

NPV=$427000+($13000 * PVIFA@16%, 4 years)

PVIFA@16%, 4 years = (1/r)*(1-(1/(1+r)^n))

=$427000+$13000 * (1/r)*(1-(1/(1+r)^n))

=$427000+$13000 * (1/0.16)*(1-(1/(1+0.16)^4))

=$427000+$13000 * 2.79818064

NPV=$463,376.35

EAC =NPV / PVIFA @16%, 4 years

=$463376.35 / 2.79818064

EAC = $165,599.15

Machine B:

NPV = Initial cost + PV of all operating costs

NPV=$390000+($6500 * PVIFA@16%, 3 years)

PVIFA@16%, 3 years = (1/r)*(1-(1/(1+r)^n))

=$390000+$6500 * (1/r)*(1-(1/(1+r)^n))

=$390000+$6500 * (1/0.16)*(1-(1/(1+0.16)^3))

=$390000+$6500 * 2.24588954

NPV= $404,598.28

EAC =NPV / PVIFA @16%, 3 years

=$404598.28 / 2.24588954

EAC=$180,150.57

Answer will be A, as its EAC is $14,551.41 less than that of Machine B ($180150.57 - $165599.15)