IBM is interested in acquiring some new equipment. Machine A costs $30,000 up front and will...

IBM is interested in acquiring some new equipment. Machine A costs $30,000 up front and will last 5 years. It costs $4000 per year to run. Machine B costs $15,000 up front and will last 2 years. B costs $6000 per year to run. IBM plans to replace the equipment as needed. The 2 machines perform the same function. The interest rate is 12%. Which machine should they choose? And why?

Expert Solution

Solution :

The Equivalent Annual cost of Machine A = - $ 12,322.29

The Equivalent Annual cost of Machine B = - $ 14,875.47

The Equivalent Annual cost of Machine A at - $ 12,322.29 is lower than that of Machine B. Thus, Machine A should be chosen.

Note :

Equivalent Annual Cost is one of the methods used in making Capital budgeting decisions . It is used in the analysis of mutually exclusive projects that have unequal lives. As per this method, the project with a lower EAC should be chosen as it results in a lower cash outflow.

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.

jeff jeffy answered 1 year ago

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