Question

Gateway Tours is choosing between two bus models. One is more expensive to purchase and maintain, but lasts much longer than the other. Its discount rate is 12%. It plans to continue with one of the two models for the foreseeable future. Based on the costs of each model shown below, which should it choose?

Model/ Time	0	1	2	3	4	5	7
Old Reliable	−200	−5	−5	−5	−5	−5	−5
Short and Sweet	−100	−3	−3	−3	−3

Old ReliableShort or Sweet    

Answer 1

Witthout solving it is quite clear that Short and sweet will cost less

We will have to calculate EAC Equivalant Annual cost

Equivalent annual cost (EAC) is the annual cost of owning and maintaining an asset determined by dividing the present value of the asset purchase, operations and maintenance cost by the present value of annuity factor

OLD RELIABLE

Year	Cash Flow	PV Factor @ 12%	Present Value
0	200	1.00	200.00
1	5	0.89	4.46
2	5	0.80	3.99
3	5	0.71	3.56
4	5	0.64	3.18
5	5	0.57	2.84
6	5	0.51	2.53
7	5	0.45	2.26
	Present Value Annuity Factor	5.56	222.82

EAC = 222.82 / 5.56 = 40.04

Short & Sweet

Year	Cash Flow	PV Factor @ 12%	Present Value
0	100	1.00	100.00
1	3	0.89	2.68
2	3	0.80	2.39
3	3	0.71	2.14
4	3	0.64	1.91
	Present Value Annuity Factor	4.04	109.11

EAC = 109.11 / 4.04 = 27.02

Since EAC of Short and sweet is less we should choose short and sweet