Question

8. Your firm is required to invest in new capital equipment to comply with a change in environ- mental regulations. As such, there is no revenue stream associated with this investment. The technologies available are shown below. The cost of funds is 12%. Sanzen 500 Tuborger 760 Initial cost Annual operating cash flow Asset life Estimated residual value after tax -1,200,000 - 100,000 3 years + 100,000 -1,400,000 -130,000 4 years +100,000 Tuborger is a company with which your firm has a long-standing relationship and with which it has completed successfully a number of technology projects in the past. Sanzen is an inno vative new firm which has broken into the market based upon the reputation of its relatively hip young executive management, who are strongly commited to "inclusion and diversity (as well as to a casual dress code and to "having fun at work"). In the space below, perform the computations necessary to decide between the alternatives. On the basis of this computation, state which you would select and why.

Answer 1

To decided between 2 equipment we will compute EAC and lowest eac will be selected.

EAC i.e. Equivalent annual cost = Present value of cash outflow/Annuity factor

Sanzen 500

Present value of cash outflow = Initial cost+ Annual cost*PVAF (12%,3)- Residual value*PVIF (12%,3)

= 1200000+100000* PVAF (12%,3)- 100000 *PVIF (12%,3)

= 1369005

EAC =1369005/PVAF (12%,3) i.e.569983

Tuborger 760

Present value of cash outflow = Initial cost+ Annual cost*PVAF (12%,4)- Residual value*PVIF (12%,4)

= 1400000+130000* PVAF (12%,4)- 100000 *PVIF (12%,4)

= 1731304

EAC =1731304/PVAF (12%,4) i.e.570004

Sanzen 500 should be selected since EAC is lower