Question

in order to make a replacement decision, a firm calculated the equivalent annual cost of owning an asset as follows: replacement period salvage value eac capital costs annual repair costs eac repair costs 1 $1,420 $1,287 - - 2 $1,102 $1,082 $400 $189 3 $910 $976 $600 $298 4 $795 $812 $800 $437 5 $580 $673 $1,200 $592 when should the firm replace its equipment? question 14 options: in 1 year in 3 years in 2 years in 4 years in 5 years

Answer 1

The firm should replace its equipment when the Equivalent Annual Cost (EAC) is the lowest, which is in Year 4 with a total EAC of $1,249.

Step-by-step explanation:

The firm should replace its equipment at the point where the Equivalent Annual Cost (EAC) is the least. This approach will minimize the total cost over the lifespan of the equipment. To find when the firm should replace its equipment, we need to look at the option where the sum of the capital costs EAC and repair costs EAC per year is the lowest. In this case, we compare the costs for each year:

• Year 1: $1,287 (capital costs EAC only)
• Year 2: $1,082 (capital costs EAC) + $189 (repair costs EAC) = $1,271
• Year 3: $976 (capital costs EAC) + $298 (repair costs EAC) = $1,274
• Year 4: $812 (capital costs EAC) + $437 (repair costs EAC) = $1,249
• Year 5: $673 (capital costs EAC) + $592 (repair costs EAC) = $1,265

The lowest total EAC is in Year 4, with a total of $1,249. Therefore, the firm should plan to replace its equipment in 4 years.