Question

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1500, will require servicing of $200 per year, and last five years. Option B will cost $1000, require servicing of $100 per year, and last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners

Answer 1

If the cost of capital is 8%, the best option is the B, which will cost $1000, require $100 maintenance per year, and will last for three years. Because this option will have an equivalent higher annual annuity.

To better understand, let's calculate the annual annuity for each option.

Option A:

Cost = $1,500.00

Maintenance cost = $200.00

Life period = 5 years

Cost of capital = 8%

To calculate it is necessary to consult the PVIFA calculator, so we have:

Equivalent annual annuity = [$1,500.00 + ($200.00 x PVIFA8%.5)] / PVIFA8%,5

[$1,500.00 + ($200.00 x 3.9927)] / 3.9927

= $575.68

Option B:

Cost = $1,000.00

Maintenance cost = $100.00

Lifespan = 3 years

Cost of capital = 8%

Using the same formula we have:

Equivalent annual annuity = [$1,000.00 + ($100.00 x PVIFA8%,3)] / PVIFA8%,3

= [$1,000.00 + ($100.00 x 2,5771)] / 2,5771

= $488.03

Therefore, it is concluded that option B is the most effective for the company.

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