You are considering the purchase of one of two machines required in your production process. Machine A has a life of two years. Machine A costs $50 initially and then $70 per year in maintenance. Machine B has an initial cost of $90. It requires $40 in maintenance for each year of its three-year life. Either machine must be replaced at the end of its life. Which is the better machine for the firm? The discount rate is 15 percent and the tax rate is zero.
A)Machine A, because EAC for machine A is $100.76
B)Machine B, because EAC for machine B is $79.42
C)Machine A, because PV of costs for machine A is $163.80
D)Machine B, because PV of costs for machine B is $181.33

Question

Quizplus · Accepted Answer

To determine the better machine, we need to calculate the equivalent annual cost (EAC) of both machines. 
For Machine A:
Initial cost = $50
Maintenance cost = $70 per year for 2 years
Discount rate = 15%

EAC = ($50 + $70/0.15) x (0.15/1-1/1.15^2) = $100.76

For Machine B:
Initial cost = $90
Maintenance cost = $40 per year for 3 years
Discount rate = 15%

EAC = ($90 + $40/0.15) x (0.15/1-1/1.15^3) = $79.42

Therefore, the better machine for the firm is Machine B, as it has a lower EAC than Machine A.

You Are Considering the Purchase of One of Two Machines