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3. (10 points) The Best Company is reviewing two options for replacing a piece of machinery....

3. (10 points) The Best Company is reviewing two options for replacing a piece of machinery. The first machine costs $86,500 and has a four-year life. The second machine costs $123,000 and has a six-year life. Neither machine will have a salvage value. The machines will be replaced at the end of their life. Determine which machine to purchase? The discount rate is 20%.

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Answer #1

Equivalent Annual Annuity =

r (NPV) 1-(1+r)-1

Where, r = discount rate

NPV = Net Present Value/ cost of machine

n= no of years

Equivalent Annual Annuity of Machine 1 =

.20 (86500) 1-(14.20)--  

= $ 33414

Equivalent Annual Annuity of Machine 2 =

-20 (123000) 1-(1+.20-6

= $36987

EAA of Machine 2 is higher therefore machine 2 is selected

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