Question

Suppose that your firm is trying to decide between two machines that will do the same job. Machine A costs $50,000, will last for ten years and will require operating costs of $5,000 per year. At the end of ten years it will be scrapped for $10,000. Machine B costs $60,000, will last for seven years and will require operating costs of $6,000 per year. At the end of seven years it will be scrapped for $5,000. Which is a better machine and why? (discount rate is 10 percent)

		A.  A is a better machine because it has a larger NPV.
		B.  A is a better machine because it has a smaller Equivalent Annual Cost.
		C.  B is a better machine because it has a larger NPV.
		D.  B is a better machine because it has a smaller Equivalent Annual Cost.
		E.  B is a better machine because it has a larger Equivalent Annual Cost.

Answer 1

B.  A is a better machine because it has a smaller Equivalent Annual Cost.

Lower the cost, better it is

Machine A requires lesser outflow each year

Machine A:

Net Outflow = 50,000+5000*PVAF(10%,10 years) – 10,000*PVF(10%, 10 years)

= 50,000 + 5000*6.145-10,000*0.386

=76,865

EAC = Net Cash Outflow/PVAF(10%, 10 years) = 12,509

Machine B :

Net Outflow = 60,000+6000*PVAF(10%,7 years) – 5,000*PVF(10%, 7 years)

= 60,000 + 6000*4.868-5,000*0.513

=86,643

EAC = 17,798