Copyright

You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $59,000, has a...

Question:

You are evaluating two different cookie-baking ovens.

The Pillsbury 707 costs $59,000, has a 5-year life, and has an annual OCF (after tax) of -$10,400 per year.

The Keebler CookieMunster costs $92,000, has a 7-year life, and has an annual OCF (after tax) of -$8,400 per year. If your discount rate is 11%, what is each machine's EAC? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

Effective Annual Cost (EAC):

The effective annual cost covers a non-constant stream of costs associated with a project into an annuity of cost. In this way, the effective annual cost provides a straightforward assessment of the cost.

Answer and Explanation:

We can use the following formula to compute the equivalent annual cost:

  • {eq}\displaystyle \frac{F*r}{1 - (1 + r)^{-T}} + C {/eq}

where {eq}F{/eq} is the initial cost, {eq}r{/eq} is discount rate, {eq}T{/eq} is the length of the project and {eq}C{/eq} is the annual cost.

For Philsbury 707,

  • Cost = $59,000
  • Life = 5 years
  • Annual cost = - annual OCF = $10,400

The equivalent annual cost is:

  • {eq}\displaystyle \frac{59,000*11\%}{(1 - (1 + 11\%)^{-5})} + 10,400 = $26,363.65 {/eq}

For Keeble CookieMunster,

  • Cost = $92,000
  • Life = 7 years
  • Annual cost = - annual OCF = $8,400

The equivalent annual cost is:

  • {eq}\displaystyle \frac{92,000*11\%}{(1 - (1 + 11\%)^{-7})} + 8,400 = $27,923.80 {/eq}

Learn more about this topic:

Loading...
How to Calculate the Present Value of an Annuity

from Business 110: Business Math

Chapter 8 / Lesson 3
11K

Related to this Question

Explore our homework questions and answers library