ExpertEasy2 marksMultiple Choice
ACCA · Question 06 · Investment Appraisal
Section A
OreCrush Mining is deciding on the replacement cycle for its heavy excavators. A new excavator costs $200,000. If replaced every 4 years, the present value of all costs (initial purchase, maintenance, and scrap value) discounted at the company's cost of capital of 8% is $250,000.
The 4-year cumulative annuity factor at 8% is 3.312.
What is the Equivalent Annual Cost (EAC) of replacing the excavator every 4 years?
Section A
OreCrush Mining is deciding on the replacement cycle for its heavy excavators. A new excavator costs $200,000. If replaced every 4 years, the present value of all costs (initial purchase, maintenance, and scrap value) discounted at the company's cost of capital of 8% is $250,000.
The 4-year cumulative annuity factor at 8% is 3.312.
What is the Equivalent Annual Cost (EAC) of replacing the excavator every 4 years?
Answer options:
A.
$60,386
B.
$62,500
C.
$75,483
D.
$82,800
How to approach this question
To find the Equivalent Annual Cost (EAC), divide the total Present Value of all costs over the cycle by the cumulative annuity factor for the cycle length.
Full Answer
C.$75,483✓ Correct
The Equivalent Annual Cost (EAC) is calculated by dividing the total present value of costs associated with a replacement cycle by the annuity factor for that cycle's duration at the given cost of capital.
EAC = $250,000 / 3.312 = $75,483.09 (rounded to $75,483).
Common mistakes
Dividing the initial cost ($200,000) by the annuity factor instead of the total PV of costs ($250,000), or simply dividing the PV by the number of years (4) without using the annuity factor.
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