Question

ABC Company is considering purchasing manufacturing equipment from two different suppliers. Equipment A has a purchase price of $2.9 million and will cost $80,000, pre-tax, to operate on an annual basis. Equipment B, on the other hand, has an initial cost of $5.7 million and costs $69,000, pre-tax, annually. Equipment A will have to be replaced every 8 years and has a salvage value of $340,000, while equipment B has a useful life of 12 years with a salvage value of $420,000. Both equipment sets are in CCA class 43. Assume the company has other assets and UCC is always positive in the asset class. The tax rate is 35 percent, and the discount rate is 13 percent. Calculate the EAC for each equipment set, and decide which manufacturing equipment to purchase.

Answer 1

The question involves calculating the Equivalent Annual Cost (EAC) for two pieces of manufacturing equipment considering their purchase price, operational costs, lifespan, salvage value, and tax considerations to determine which one is more economical to purchase.

Step-by-step explanation:

The student's question revolves around the calculation of the Equivalent Annual Cost (EAC) for two different manufacturing equipment options to determine which one is more cost-effective to purchase. The decision necessitates an understanding of the present value of costs over the equipment's lifespan, accounting for purchase price, operational costs, salvage value, and tax implications.

Calculation of EAC for Equipment A

Initial cost: $2.9 million

Annual operational cost (pre-tax): $80,000

Useful life: 8 years

Salvage value: $340,000

Calculation of EAC for Equipment B

Initial cost: $5.7 million

Annual operational cost (pre-tax): $69,000

Useful life: 12 years

Salvage value: $420,000

The EAC is the annual cost of owning and operating the equipment over its lifetime, considering the time value of money. To determine which equipment to purchase, one would calculate the EAC for both equipment A and B. The equipment with the lower EAC is generally the more cost-effective choice.