Projects with different lives: Your firm is deciding whether to purchase a durable delivery vehicle or a short-term vehicle. The durable vehicle costs $25,000 and should last five years. The short-term vehicle costs $10,000 and should last two years. If the cost of capital for the firm is 15 percent, then what is the equivalent annual cost for the best choice for the firm? (Round to the nearest dollar.)

Question

Quizplus · Accepted Answer

First, we need to calculate the present value of each option using the cost of capital of 15%.
For the durable vehicle: PV = $25,000/(1+0.15)^1 + $25,000/(1+0.15)^2 + $25,000/(1+0.15)^3 + $25,000/(1+0.15)^4 + $25,000/(1+0.15)^5 = $75,155.73
For the short-term vehicle: PV = $10,000/(1+0.15)^1 + $10,000/(1+0.15)^2 = $16,690.14
Next, we need to calculate the equivalent annual cost (EAC) for each option.
For the durable vehicle: EAC = $75,155.73 / ((1-1/(1+0.15)^5)/0.15) = $22,645.96
For the short-term vehicle: EAC = $16,690.14 / ((1-1/(1+0.15)^2)/0.15) = $6,151.13
Therefore, the best choice for the firm is the short-term vehicle with an equivalent annual cost of $6,151.13.

Projects with Different Lives: Your Firm Is Deciding Whether to Purchase