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

Machine A	0	1	2	3	4	5	6	7	8	9	10
Initial Invetsment	-50000
Operating Costs		-5000	-5000	-5000	-5000	-5000	-5000	-5000	-5000	-5000	-5000
Scrape Value											10000
Total Cash Flow	-50000	-5000	-5000	-5000	-5000	-5000	-5000	-5000	-5000	-5000	5000
NPV =	-76867.40
Equivalent Annual Cost = r * NPV/[(1 -(1+r)^-n]
	-12509.82
Machinne B	0	1	2	3	4	5	6	7
Initial Invetsment	-60000
Operating Costs		-6000	-6000	-6000	-6000	-6000	-6000	-6000
Scrape Value								5000
Total Cash Flow	-60000	-6000	-6000	-6000	-6000	-6000	-6000	-1000
NPV =	-86644.72
Equivalent Annual Cost = r * NPV/[(1 -(1+r)^-n]
	-17797.30248

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