Question

Use Annual Cost Analysis to determine whether Alternative A or B should be chosen. The analysis period is 5 years. Assume an interest rate of 6% per year, compounded annually Alternative A Alternative B Initial Cost 2800 6580 Annual Benefit 450 940 Salvage Value 500 1375 Useful Life (yrs) 5 5 Group of answer choices Alternative A should be chosen, because its initial cost is lower than Alternative B's Alternative A should be chosen, because its equivalent annual cost is $252.15 lower than Alternative B's Alternative B should be chosen, because its annual benefit is higher than Alternative A's Alternative B should be chosen, because its equivalent annual cost is $252.15 higher than Alternative A's

Answer 1

Answer:

A should be chosen, because its equivalent annual cost is $252.15 lower than Alternative B's.

Explanation:

a) Data and Calculations:

Interest rate = 6% per year

                       Alternative A      Alternative B

Initial Cost             2800                 6580

Annual Benefit        450                   940

Salvage Value        500                  1375

Useful Life (yrs)        5                        5

Annuity factor = 4.212 for 5 years at 6%.

Present value factor = 0.747 for 5 years at 6%.

                              Alternative A      Alternative B

Present value of

 annual benefits       $1,895.40       $3,959.28

PV of salvage value       373.50           1,027.12

Total present value

of benefits               $2,268.90       $4,986.40

Initial Cost                  2,800               6,580

Net present value       $531.10        $1,593.60

The equivalent annual cost

= NPV/PV annuity factor

                             ($531.10/4.212)   ($1,593.60/4.212)

Equivalent annual cost $126.09      $378.35

Difference:

Alternative B = $378.35

Alternative A = $126.09

Difference =    $252.26