J&J Automotive is analyzing two machines to determine which one they should purchase. The company requires a 16% rate of return and the machinery belongs in a 30% CCA class. Machine A
Has a cost of $427,000, annual operating costs of $13,000, and a 4-year life. Machine B costs
$390,000, has annual operating costs of $6,500, and has a 3-year life. Whichever machine is
Purchased will be replaced at the end of its useful life. Which machine should J&J purchase and
Why? Ignore taxes.

Question

Quizplus · Accepted Answer

We can calculate the equivalent annual cost (EAC) for each machine and compare them to determine which one has a lower cost per year.

For Machine A, we need to calculate the present value of the initial cost ($427,000), the annual operating costs ($13,000), and the salvage value at the end of the 4-year life. Assuming a salvage value of zero and a 16% rate of return, the present value is:

PV = -$427,000 - $13,000(P/A,16%,4)
PV = -$427,000 - $40,898.19
PV = -$467,898.19

Now we can calculate the EAC:

EAC = (PV)(.16)(1.16^4)/((1.16^4)-1)
EAC = (-$467,898.19)(.16)(1.16^4)/((1.16^4)-1)
EAC = $162,408.19

For Machine B, we follow the same process:

PV = -$390,000 - $6,500(P/A,16%,3)
PV = -$390,000 - $21,510.84
PV = -$411,510.84

EAC = (PV)(.16)(1.16^3)/((1.16^3)-1)
EAC = (-$411,510.84)(.16)(1.16^3)/((1.16^3)-1)
EAC = $176,856.78

Therefore, Machine A has an EAC of $162,408.19 and Machine B has an EAC of $176,856.78. Machine A is the better choice because it has the lower EAC. Specifically, Machine A has an EAC that is $14,448.59 less than Machine B (not $14,551.41 as stated in option B).

J&J Automotive Is Analyzing Two Machines to Determine Which One