Question

You are starting a vegan restaurant and need to buy a vehicle for delivery orders. You have two models in mind. Model A costs $10,000 and is expected to run for 6 years; Model B is more expensive, with a price of $15,000 and an expected life of 10 years. The annual maintenance costs are $800 for Model A and $700 for Model B. Assume that the opportunity cost of capital is 10.6 percent.

Using the information provided in the question, which model would you choose based on the relevant analysis?

Answer 1

To decide which model to buy, we can use the equivalent annual cost as the tool for analysis. The model which has the lowest equivalent annual cost can then be selected.

Present value of costs model A = $ 13423.79

The annuity factor is calculated as follows

Present value of costs model B = $ 19192.5

Equivalent annual cost model B = $ 3204.5

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Based on the equivalent annual cost analysis, model A is selected because it has a lower equivalent annual cost compared to model B.