You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $25,000, has a six-year life, and has an annual OCF (after tax) of -$5,000 per year. The Keebler CookieMunster costs $40,000, has a seven-year life, and has an annual OCF (after tax) of -$500 per year. If your discount rate is 10 percent, what is each machine's EAC?

Question

Quizplus · Accepted Answer

To calculate the EAC (Equivalent Annual Cost), we need to use the following formula:
EAC = (Cost of equipment + Annual OCF) x PVIFA(rate, life of equipment)
Where PVIFA is the Present Value Interest Factor of an Annuity, which can be looked up in a Present Value Interest Factor table.

For the Pillsbury oven:
Cost of equipment = $25,000
Annual OCF = $5,000
PVIFA (10%, 6 years) = 4.355
EAC = ($25,000 + $5,000) x 4.355 = $120,706.60 / 10 = $10,740.18

For the Keebler CookieMunster:
Cost of equipment = $40,000
Annual OCF = $500
PVIFA (10%, 7 years) = 4.868
EAC = ($40,000 + $500) x 4.868 = $197,766.60 / 10 = $19,776.66

Therefore, the best choice is the Pillsbury oven, since it has a lower EAC ($10,740.18) compared to the Keebler CookieMunster ($19,776.66).

You Are Evaluating Two Different Cookie-Baking Ovens