3.GHI company wants to buy an air conditioner. There are two options in the market. The...

3.GHI company wants to buy an air conditioner. There are two options in the market. The discount rate is 17%. Option A: Super air conditioner cost $300 to purchase, can be used for 5 years, and the electricity bill is $150 per year. Option B: Excellent air conditioner cost $500 to purchase, can be used for 8 years, and the electricity bill is $100 per year.

a) What are the equivalent annual costs (EAC) of the Super and Excellent air conditioner models?

b) Which model is more cost-effective (with lower cost)?

c) If the inflation rate is expected to be 10% per year, redo a.) and b.)

Solutions

Expert Solution

EAC = Present value of Cost/(PVIF i%,n)

Calculation of Present value of cost (A)

PV (A) = Initial cost + Annual cost(PVIF i%,n)

PV (A) = 300 + 150(PVIF17%,5)

PV (A) = 300 + 150*3.1993

PV (A) = $ 780

Present value of cost for (B)

PV (B) = 500 + 100(PVIF17%,8)

PV (B) = 500 + 100*4.2072 = $921

Calculation of EAC

EAC (A) = 780/3.1993 = $243.80

EAC (B) = 921/4.20716 = $218.91

Based on EAC, Option (B) is the more cost effective , because of lower cost

(C)..Calculation of annual cost inculding inflation

Years	Inflation factor	Option (A)	Option (B)	PVIF17%	PV (A)	PV (B)
1	1.10	165	110	0.8547	141.03	94.02
2	1.21	181.50	121	0.7305	132.59	88.39
3	1.331	199.65	133.10	0.6244	124.66	83.11
4	1.4641	219.62	146.41	0.5337	117.21	78.14
5	1.61051	241.58	161.05	0.4561	110.18	73.45
6	1.771561		177.16	0.3898		69.06
7	1.9487171		194.87	0.3332		64.93
8	2.14358881		214.36	0.2848		61.05
	Sum (ups)				625.67	612.15

Present Value (A) = 300+625.67 = $925.67

Present value (B) = 500 + 612.15 = 1,112.15

EAC (A) = 925.67/3.1993 = $289.33

EAC (B) = 1,112.15/4.20716 = $264.35

Still the option (B) is more cost effective

jeff jeffy answered 1 year ago

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