Question

A firm is considering replacing the existing industrial air conditioning unit. They will pick one of two units. The first, the AC360, costs $26,371.00 to install, $5,188.00 to operate per year for 7 years at which time it will be sold for $7,079.00. The second, RayCool 8, costs $41,074.00 to install, $2,101.00 to operate per year for 5 years at which time it will be sold for $8,973.00. The firm’s cost of capital is 6.60%. What is the equivalent annual cost of the RayCool8? Assume that there are no taxes.

Answer 1

Option 1-	AC 360		Option 2-	Ray Cool 8
	$			$
Cost	26,371.00		Cost	41,074.00
Installation	5,188.00		Installation	2,101.00
Life	7 Years		Life	5 years
Scrap Val	7,079.00		Scrap Val	8,973.00
The firms cost of capital is 6.6%, lets take out the PV factors for 7 years
Year	Rate	PVF	Formula Used
1	0.066	0.9380863	=1/(1+B13)^A13
2	0.066	0.8800059	=1/(1+B14)^A14
3	0.066	0.8255215	=1/(1+B15)^A15
4	0.066	0.7744104	=1/(1+B16)^A16
5	0.066	0.7264638	=1/(1+B17)^A17
6	0.066	0.6814857	=1/(1+B18)^A18
7	0.066	0.6392924	=1/(1+B19)^A19
Analysis of the options		AC 360
Particulars	Year	Amount	PVF	Amt x PVF
Purchase cost	0	26,371.00	1.00	26,371.00
Installation cost	0	5,188.00	1.00	5,158.00
Scrap Value	7	(7,079.00)	0.64	(4,525.55)
			NPV	27,003.45
			Life	7 Years		Formula
			Equated annual cost	3857.6355		=+E27/7
Analysis of the options		Ray Cool 8
Particulars	Year	Amount	PVF	Amt x PVF
Purchase cost	0	41,074.00	1.00	41,074.00
Installation cost	0	2,101.00	1.00	5,158.00
Scrap Value	7	(8,973.00)	0.64	(5,736.37)
			NPV	40,495.63
			Life	5 Years		Formula
			Equated annual cost	5785.0899		=+E38/7
On comparing both the option, we can conclude that option 1 is better as the equated annual cost is low in option 1