Question

Sunset Bakers needs to purchase an oven. They are considering two alternatives:

Alternative 1: A Conventional Oven will cost $12,000 and can be expected to last 8 years, and will have a salvage value of $1,000 at the end of year 8. The cost of electricity used will be $2,500 per year. Maintenance cost will be $200 per year. In year 4 the heating element will need to be replaced at a cost of $850.

Alternative 2: A High efficiency Oven will cost $14,500 and can be expected to last 8 years, and will have a salvage value of $2,000 at the end of year 8. The cost of electricity used will be $2,000 per year. Maintenance cost is will be $250 per year. In year 4 the heating element will need to be replaced at a cost of $850. In year 5 the fan motor will need to be replaced at a cost of $500. Assume the services provided by the ovens are identical; assume an interest rate of 10%.

Compare the ANNUAL EQUIVALENT costs of the 2 alternatives and make a recommendation for selection.

Answer 1

Solution :

The Annual Equivalent cost of Alternative 1 = Conventional Oven = - $ 4,970.71

= $ 4,971 ( when rounded off to the nearest whole number )

The Annual Equivalent cost of Alternative 2 = High Efficiency Oven = - $ 4,960.07

= $ 4,960 ( when rounded off to the nearest whole number )

The alternative 2 i.e., High Efficiency Oven has a lower Annual Equivalent cost when compared to alternative 1 i.e., Conventional Oven

Thus the Alternative 2 i.e., High Efficiency Oven with lower Annual Equivalent cost of - $ 4,960 should be selected.

Please find the attached screenshots of the excel sheet containing the detailed calculation for the solution.