Question

A firm is considering replacing the existing industrial air conditioning unit. They will pick one of two units. The first, the AC360, costs $26,332.00 to install, $5,174.00 to operate per year for 7 years at which time it will be sold for $6,909.00. The second, RayCool 8, costs $41,036.00 to install, $2,011.00 to operate per year for 5 years at which time it will be sold for $9,056.00. The firm’s cost of capital is 5.60%. What is the equivalent annual cost of the AC360? Assume that there are no taxes.

ROUND TO 2 DECIMAL PLACES. THANK YOU IN ADVANCE.

Answer 1

Equivalent annual cost is the annual cost of owning and maintaining an asset calculated by dividing the net present value of the asset purchase and maintenance cost discounted to the present value.

NPV of the AC360 = 26332+ 5174/1.056 + 5174/1.056^2 + 5174/1.056^3 + 5174/1.056^4 + 5174/1.056^5 +5174/1.056^6 + 5174/1.056^7 - 6909/1.056^7

= $55,630.43 - 4718.11

= $ 50,912.32

Equivalent annual cost for the AC360 = NPV*r/(1- (1+r)^-n)

= 50912.32*.056/(1- 1.056^-7)

= $8,990.94

Therefore, the annual cost for AC360 is $8,990.94