Question

In: Finance

Tisla Motors needs to select an assembly line for producing their new SUV. They have two...

Tisla Motors needs to select an assembly line for producing their new SUV. They have two options:

Option A is a highly automated assembly line that has a large up-front cost but low maintenance cost over the years. This option will cost $9 million today with a yearly operating cost of $2 million. The assembly line will last for 5 years and be sold for $5 million in 5 years.

Option B is a cheaper alternative with less technology, a longer life, but higher operating costs. This option will cost $6 million today with an annual operating cost of $3 million. This assembly line will last for 8 years and be sold for $1 million in 8 years.

The firm’s cost of capital is 12%. Assume a tax rate of zero percent. The equivalent annual cost (EAC) of better option should be $_______ million.

a. 3.409

b. 3.552

c. 3.710

d. 3.867

e. 4.127

PLEASE SHOW YOUR WORK

Solutions

Expert Solution

rate 12.0000%
Cash flows Year Discounted CF= cash flows/(1+rate)^year Cumulative cash flow
                        9.00 0                                        9.00                                    9.00
                     2.000 1                                        1.79                                  10.79
                     2.000 2                                        1.59                                  12.38
                     2.000 3                                        1.42                                  13.80
                     2.000 4                                        1.27                                  15.07
                     2.000 5                                        1.13                                  16.21

Present worth of A = 16.21

PV = 16.21, FV = 0, N = 5, rate = 12%

use PMT function in Excel

EAC =4.50

rate 12.0000%
Cash flows Year Discounted CF= cash flows/(1+rate)^year Cumulative cash flow
                        6.00 0                                        6.00                                    6.00
                     3.000 1                                        2.68                                    8.68
                     3.000 2                                        2.39                                  11.07
                     3.000 3                                        2.14                                  13.21
                     3.000 4                                        1.91                                  15.11
                     3.000 5                                        1.70                                  16.81
                     3.000 6                                        1.52                                  18.33
                     3.000 7                                        1.36                                  19.69
                     3.000 8                                        1.21                                  20.90
                   (1.000) 8                                     (0.40)                                  20.50

PV = 20.50, FV = 0, N = 12, rate = 12%

use PMT function in Excel

EAC of B = 4.127

so option e is the answer


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