ExpertMedium2 marksMultiple Choice
ACCA · Question 04 · Investment Appraisal
Section A
DeepSea Minerals PLC is evaluating two mutually exclusive underwater extraction machines with different useful lives. Machine X costs $400,000, has a 3-year life, and an NPV of costs of $520,000. Machine Y costs $550,000, has a 5-year life, and an NPV of costs of $710,000. The company's cost of capital is 10%.
What is the Equivalent Annual Cost (EAC) of Machine Y? (Annuity factor for 10% at 5 years is 3.791)
Section A
DeepSea Minerals PLC is evaluating two mutually exclusive underwater extraction machines with different useful lives. Machine X costs $400,000, has a 3-year life, and an NPV of costs of $520,000. Machine Y costs $550,000, has a 5-year life, and an NPV of costs of $710,000. The company's cost of capital is 10%.
What is the Equivalent Annual Cost (EAC) of Machine Y? (Annuity factor for 10% at 5 years is 3.791)
Answer options:
A.
$145,080
B.
$187,286
C.
$209,102
D.
$710,000
How to approach this question
Use the formula for Equivalent Annual Cost (EAC) = Present Value of Total Costs / Annuity Factor for the life of the asset.
Full Answer
B.$187,286✓ Correct
To compare assets with different useful lives, we calculate the Equivalent Annual Cost (EAC). The formula is EAC = NPV of costs / Annuity Factor. For Machine Y: $710,000 / 3.791 = $187,285.67 (rounded to $187,286).
Common mistakes
Dividing only the initial capital cost by the annuity factor, forgetting that the NPV of costs already includes the initial cost and running costs.
Practice the full ACCA FM — Financial Management Practice Exam 6
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