Present Value and final decisions

Curlyben · Feb 10, 2010, 03:20 AM

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shadow429 · Feb 10, 2010, 08:19 AM

I don't know the answer I spent like an hour on it alone, trying to figure out exactly how to find the answer.................I'm so confused and I've tried so many different ways of doing it that I have no idea where to go from anymore.....

ArcSine · Feb 10, 2010, 10:04 AM

Picking the best machine involves your calculation of what's called "equivalent annual cost".

First determine the after-tax cash flows for both machines. All the info for this calc is there, with the SL depreciation assumption, and the given tax rate.

Next, calculate the NPV for each machine, by discounting the after-tax cash flows at the given cost of capital.

Finally, determine the annuity amount which has the same NPV as each machine, where the annuity's life is the same as that of the machine. For example, for the high-efficiency machine, what annual, level payment (annuity), with 8 payments, has the same NPV as the machine? Similarly, what 6-year annuity, one payment per year, has the same NPV as the ordinary washer?

The annuity that you calculate--one for each machine--represents each machine's "equivalent annual cost". Then you just go with the one that has the lower EAC.

Present Value and final decisions

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