Question

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

Answer 1

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