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1. Your company wants to bring outdoor ice-skating to Palm Springs, California and must choose between two refrigeration machines that do the same job but have different life spans. The two machines have the following investment and operating costs in each year:
Year
0
1
2
3
Machine A
$10,000
$1,100
$1,100 & Replace
Machine B
$12,000
$1,200
$1,300 & Replace
These costs are expressed in real (inflation adjusted) terms. Assume a 5 percent real discount rate. Note that machine A would operate in periods 1 and 2 only, while machine B would operate in periods 1 through 3.
A. Explain whether the concept of Equivalent Annual Cost (EAC) would be useful for evaluating these two investments. In your answer, please define EAC.
B. As the company's financial manager, if you had to buy one or the other machine, which one would you buy. Why?
C. Now suppose you have an existing machine that you can keep operating for one more year only, but it will cost $2,500 in repairs and $1,800 in operating costs. Is it worth replacing with machine A or B?
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