Question

Projects with different lives: You are trying to choose between purchasing one of two machines for a factory. Machine A costs $15,000 to purchase and has a three-year life. Machine B costs $17,700 to purchase but has a four year life. Regardless of which machine you purchase, it will have to be replaced at the end of its operating life. Which machine should you choose? Assume a marginal tax rate of 35percent and a discount rate of 15percent

Answer 1

Answer:

Machine B

Explanation:

In this question we have to find out the equivalent annual cost which is shown below:

Equivalent annual cost = (Interest Rate × Net present value) ÷ {1 - (1 + interest rate)^-number of years}

For Machine A, it would be

= (15% × -$15,000) ÷ {1 - (1 + 0.15)^-3}

= ($2,250) ÷ (1 - 0.6575162324 )

= ($2,250) ÷ (0.3424837676 )

= -$6,569.65

For Machine B, it would be

= (15% × -$17,700) ÷ {1 - (1 + 0.15)^-4}

= ($2,655) ÷ (1 - 0.5717532456 )

= ($2,655) ÷ (0.4282467544  )

= -$6,199.70

As we can see that the equivalent annual cost has less in Machine B so it would be choose