Question

Multinational Harvester Inc. ("MHI") is considering a maintenance contract for its heavy equipment.

Firm A has offered MHI a four-year contract for $100,000, to be paid in advance. Firm B has offered an eight-year contract for $165,000, also to be paid in advance. MHI will be able to save $34,000 per year under either contract because its employees will no longer have to do the work themselves. Of course, MHI can decide not to take either contract.

1. If MHI's cost of capital is 7%, which project should be selected? Use both the replacement chain and the equivalent annual annuity (EAA) method to justify your answer. (Choose "Firm A", "Firm B", or "Neither")
2. If MHI's cost of capital is 12%, does it change the decision? (Choose "Firm A", "Firm B", or "Neither")
3. Which is the best choice if the cost of capital is 14%? (Choose "Firm A", "Firm B", or "Neither")

Answer 1

a)  if cost of capital is 7%

b) If cost of capital is 12%

c) If cost of capital 14%