Question

Cloud air conditioners cost $300 to purchase, result in electricity bills of $150 per year, and last for 5 years. Luxury Air models cost $500, result in electricity bills of $100 per year, and last for 8 years. The discount rate is 21 percent. a. What are the equivalent annual costs of the Cloud and Luxury Air models? Which model is more cost effective? b. Now you remember that the inflation rate is expected to be 10 percent per year for the foreseeable future. How does the inflation rate affect the evaluation of the two air conditioners?

(Please show work by using financial calculation)

Answer 1

A. Equivalent Annual Cost = PV of Cash Outflows / PVAF (r%, n)

Computation of PV of Cash flows: & Equated Annual cost

Model Luxury AC is effective as Equated Annual cost is less.

if inflation rate is 10%

Re rate ( Nominal rate) = [( 1 + real Rate ) (1 + Inflation rate )] -1

= [(1+0.21)(1+0.10)] - 1

= [(1.21)(1.1)] - 1

= 1.331-1

= 0.331 i.e 33.10%

COmputation of Equated Annual cost if required discount rate is 33.1%

Cloud AC is advicable if required discount rate is 33.1% as the Equated Annual cost is less.

PVAF value = sum of PVF