Tool Makers NV uses tool and die machines to produce equipment for other ﬁrms.The initial cost of one customized tool and die machine is €850,000.This machine costs €10,000 a year to operate.
Each machine has a life of 3 years before it is replaced.What is the equivalent annual cost of this
Machine if the required return is 9%? (Round your answer to whole euros.)

Question

Quizplus · Accepted Answer

To calculate the Equivalent Annual Cost (EAC), we need to find the present value of all the costs associated with the machine over its lifetime and then equate it to an annuity. 
The present value of the initial cost at a 9% required return is:
PV = €850,000/(1+0.09)^1 = €778,899.08
The present value of the operating cost over 3 years is:
PV = €10,000/{(1-(1+0.09)^-3)/0.09} = €26,898.11
Therefore, the total present value is:
Total PV = €778,899.08 + €26,898.11 = €805,797.19
And the equivalent annual cost is:
EAC = €805,797.19/{[(1+0.09)^3-1]/[0.09(1+0.09)^3]} = €345,797 (rounded to the nearest euro) 
Option C is the best answer.

Tool Makers NV Uses Tool and Die Machines to Produce