Question

Little Rhody Manufacturing needs to purchase a new central air-conditioning system for a plant. There are two choices. The first system costs $70,000 and is expected to last 6 years, and the second system costs $102,000 and is expected to last 9 years. Assume that the opportunity cost of capital is 12 percent. Which air-conditioning system should you purchase

Answer 1

Answer:

The first option should be considered for purchase as its has a lesser EAC

Explanation:        

                                           Option 1          Option 2

Cost                                    $70,000           $102,000

Opportunity cost                     12%                    12%

of capital

Useful Life                             6 years             9 years

PVAF                                      4.114                 5.3282

Equated Annual Cost        $17,025.83       $19,143.43

Conclusion: The first option should be considered for purchase as its has a lesser EAC.

Working

PVAF (12%, 6 years) = 4.114

PVAF (12%, 9 years) = 5.3282

Equated annual cost = Cost / PVAF (r%, n years)