The company has a 15% cost of capital and uses straight-line depreciation to a z
ID: 2675960 • Letter: T
Question
The company has a 15% cost of capital and uses straight-line depreciation to a zero book value. Machine A requires an investment of $290,000, incurs incremental operating costs annually of $8,000, and has a 3-year life. Machine B costs $180,000, has annual operating costs of $12,000 and a 2-year life. Whichever machine is purchased will be replaced at the end of its useful life. Since the projects have unequal lives, the company realizes that the equivalent annual cost (annuity) approach will be needed. Based on the analysis, the preferable machine is ______ because it will save about $______ a year over the other.Explanation / Answer
Using Excel to find the NPV and annual worth of both machines:
How to find the NPV: use the command =NPV(interest rate, year 1 cash flow .... year 4 cash flow) + year 0 cash flow. Note, you do not include the yeat 0 cash flow into the NPV command as the NPV command only computes the NPV from year 1 onwards!
How to find AW: use the command =PMT(interest rate,number of years, Present Value) to find the uniform annual cost.
Choose machine B as it will save $54,890.21 annually
Year A B 0 -290000 -180000 1 -8000 -12000 2 -16000 -12000 3 -24000 NPV ($324,835.21) ($199,508.51) AW ($142,270.34) ($87,380.13)