Problem 6-26 EAC and Inflation Office Automation, Inc., must choose between two
ID: 2384170 • Letter: P
Question
Problem 6-26 EAC and Inflation
Office Automation, Inc., must choose between two copiers, the XX40 or the RH45. The XX40 costs $1,900 and will last for 4 years. The copier will require a real aftertax cost of $220 per year after all relevant expenses. The RH45 costs $2,400 and will last 6 years. The real aftertax cost for the RH45 will be $195 per year. All cash flows occur at the end of the year. The inflation rate is expected to be 6 percent per year, and the nominal discount rate is 13 percent.
Calculate the EAC for each copier. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
Office Automation, Inc., must choose between two copiers, the XX40 or the RH45. The XX40 costs $1,900 and will last for 4 years. The copier will require a real aftertax cost of $220 per year after all relevant expenses. The RH45 costs $2,400 and will last 6 years. The real aftertax cost for the RH45 will be $195 per year. All cash flows occur at the end of the year. The inflation rate is expected to be 6 percent per year, and the nominal discount rate is 13 percent.
Explanation / Answer
Ans.
Calculation of the EAC for each copier :-
The annual cost of owning an asset over its entire life. Equivalent annual cost is often used by firms for capital budgeting decisions. Eqivalent annual cost is calculated as:
Calculation of real Rate :-
(1 + rnominal)
= (1 + r1) ´ (1 + inflation rate)
1.13 = (1+r1) x 1.06)
r1 =1.13 / 1.06 -1
r1 = .0660 or 6.60
(Where r1 = Real rate)
EAC =
Copier XX40 =
PVAFn/i=k=1nC(1+i)k=Ci(11(1+i)n)=C(1(1+i)ni)
1900PVAF4/6.06=1900(1(1+6.06)46.06)=1900(10.000402514190421876.06)=1900(0.1649500801666)=313.4051523165
313.40 + 220 = 533.40
Copier RH45 =
PVAFn/i=k=1nC(1+i)k=Ci(11(1+i)n)=C(1(1+i)ni)
2400PVAF6/6.06=2400(1(1+6.06)66.06)=2400(18.0755441104149E66.06)=2400(0.16501516905213)=396.0364057251
396.03 + 195 = 591.03
2. The conclusion is to invest in Copier XX40 since it has a lower EAC.
Particular's Amount copier 1 Amount copier 2 Cost of copier 1900 2400 Life 2 year 4 Year Maintinance Cost 220 195