Question

Barry Boswell is a financial analyst for Dossman Metal​ Works, Inc. and he is analyzing two alternative configurations for the​ firm's new plasma cutter shop. The two​ alternatives, denoted A and B​ below, will perform the same​ task, but alternative A will cost ​$90, 000 to​ purchase, while alternative B will cost only $ 60, 000. ​Moreover, the two alternatives will have very different cash flows and useful lives. The​ after-tax costs for the two projects are as​ follows:

Year	Alternative A	Alternative B
0	($90,000)	($60,000)
1	($18,000)	($4,000)
2	($18,000)	($4,000)
3	($18,000)	($4,000)
4	($18,000)
5	($18,000)
6	($18,000)
7	($18,000)

a. Calculate each​ project's EAC, given a discount rate of 12 percent.
b. Which of the alternatives do you think Barry should​ select? Why?

Answer 1

Alternative-A
Year	Cashflows	PVF at 12%	Present value
0	-90000	1	-90000
1	-18000	0.892857	-16071.4
2	-18000	0.797194	-14349.5
3	-18000	0.71178	-12812
4	-18000	0.635518	-11439.3
5	-18000	0.567427	-10213.7
6	-18000	0.506631	-9119.36
7	-18000	0.452349	-8142.29
Present value of cashflows			-172148
Divide: Annuity Factor			4.56375
EAC			-37720.7
Alternative-B
Year	Cashflows	PVF at 12%	Present value
0	-60000	1	-60000
1	-4000	0.892857	-3571.43
2	-4000	0.797194	-3188.78
3	-4000	0.71178	-2847.12
Present value of cashflows			-69607
Divide: Annuity Factor			2.40183
EAC			-28980.8
Alternative-B shall be selected