Solution:
a. The equivalent annual cost, EAC of a new jet is
EAC = Cost of new jet/PVIFA @ i, n
EAC = $1,180,000/PVIFA @ 7%, 5
EAC = $1,180,000/[(1.07^5-1)/(0.07*1.07^5)]
EAC = $1,180,000/4.1002
EAC = $287,791.02
b. If the jet is replaced at the end of 3 year rather than year 4, the company incur an incremental cost of $287,791.02 in year 4. The present value of the cost is
PV of cost = $287,791.02/1.07^4
PV of cost = $219,554.39
c. PV of savings = ($100,000 - $21,000) (PVIFA @ 7%, 3)
PV of savings = $79,000 [(1.07^3-1)/(0.07*1.07^3)]
PV of savings = $79,000 (2.6243)
PV of savings = $207,320.97
d. No. Since the present value of savings is less than the present value of cost, the president should not allow a wider use of the present jet.
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