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As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $63,500. Its operating costs are $21,800 a year, but in five years the machine will require a $19,100 overhaul. Thereafter operating costs will be $30,900 until the machine is finally sold in year 10 for $6,350 The older machine could be sold today for $25,900. if it is kept, It wll need an immedlate $24,500 overhaul. Thereater operating costs will be $34,000 a year until the machine is finally sold in year 5 for $6,350. Both machines are fully depreciated for tax purposes. The company pays tax at 35%. Cash flows have been forecasted in real terms he real cost of capital is 13% a. Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.) Fquivalent Annual Cost Sell new machinc Sell old machine b. Which machine should United Automation sell? Sell old machine Sell new machine

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Answer #1
Equivalent annual cost (EAC) can be calculated using the following formula:
EAC =PV of the cash flows *(A/P,i,n)
Machine with higher EAC should be sold.

Calculation of EAC for new machine: Tax Rate Cash Flow of the new machine will be as follows: Year Opportunity Cost (After tax) Operating Cost Overhaul cost Salvage Value (After tax) Net Cash Flow 35% 4 10 $41,275 ($19,100) $4,128 $41,275) | ($21,800) | ($21,800) | ($21,800)「($21,800) | ($40,900) | ($30,900) | ($30,900) | ($30,900) | ($30,900) | ($26,773 12 Equivalent annual cost (EAC) can be calculated using following formula: EAC -PV of the cash flows *(A/P,i,n) 14 15 16 17 18 19 Given the following cash flow and interest rate, PV of cashflows can be calculated as follows: Year Free Cash Flow (FCF Interest rate (i) P/F,i,n) for each year Present Value of cash flows- FCF*(P/F,i,n Present value if future cash flows 10 13% 1.00 0.88 0.78 0.69 0.61 0.54 0.48 0.43 0.38 0.33 0.29 ($41,275) ($19,292) ($17,073) ($15,108) ($13,370) ($22,199) ($14,842) ($13,134) ($11,623) ($10,286)($7,887 ($186,089.92)SUM(D21:N21 24 25 26 27 Equivalent annual cost calculation: Equivalent annual cost PV of the cash flows *(A/P,i,n) PV of cash flows ($186,089.92) Interest rate 13% PV of the cash flows (A/P.i,n ($34,294.43)D27* (1/PV(D28,D29,-1,0)) 31 Equivalent annual cost 32 Hence EAC of new machine is ($34,294.43 35Calculation of EAC for old machine: Tax Rate Cash Flow of the new machine will be as follows: Year Opportunity Cost (After ta> Operating Cost Overhaul cost Salvage Value (After tax) Net Cash Flow 36 37 38 39 35% ($16,835 ($24,500 ($41,335) ($34,000) ($34,000) ($34,000) ($34,000 41 $4,128 (S29,873) Equivalent annual cost (EAC) can be calculated using following formula EAC 47 PV of the cash flows *(A/P,i,n) 49 Given the following cash flow and interest rate, PV of cashflows can be calculated as follows: Year Free Cash Flow (FCF Interest rate (i (P/F,i,n) for each year Present Value of cash flows FCF*(P/F,i,n Present value if future cash flows ($41,335) ($34,000)($34,000 ($34,000) ($34,000) ($29,873 51 52 53 1396 1.00 0.88 0.78 0.69 0.61 54 ($158,680.62) SUM(D54:154) 57 Equivalent annual cost calculation Equivalent annual cost PV of the cash flows (A/P.i,n 59 PV of cash flows ($158,680.62) 61 Interest rate Equivalent annual cost -PV of the cash flows *(A/P.i,n) ($45,115.21) D60 (1/PV(D61,D62,-1,0)) 67 Hence EAC of old machine is ($45,115.21) 70 71 Since EAC of old machine is higher therefore the old machine should be sold

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