Question

Little Rhody Manufacturing needs to purchase a new central air-conditioning system for a plant. There are two choices. The first system costs $70,000 and is expected to last 6 years, and the second system costs $102,000 and is expected to last 9 years. Assume that the opportunity cost of capital is 12 percent. Which air-conditioning system should you purchase

Answer 1

The first option should be considered for purchase as its has a lesser EAC

Explanation:

Option 1 Option 2

Cost $70,000 $102,000

Opportunity cost 12% 12%

of capital

Useful Life 6 years 9 years

PVAF 4.114 5.3282

Equated Annual Cost $17,025.83 $19,143.43

Conclusion: The first option should be considered for purchase as its has a lesser EAC.

Working

PVAF (12%, 6 years) = 4.114

PVAF (12%, 9 years) = 5.3282

Equated annual cost = Cost / PVAF (r%, n years)