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Actom is evaluating the operating costs of two types of equipment. The standard model costs R50,000 and will have a useful life of four years. Operating costs are expected to be R5,000 per year. The superior model costs R90,000 and will have a useful life of six years. Its operating costs are expected to be R3,000 per year. Both models will be able to operate at the same level of output and quality and generate the same earnings. Actom’s cost of capital is 10 percent.
Required:
1. Calculate the present values of each of the cash cost over the useful life of each model.
2. Can the two present values be compared? If not, why not?
3. What is the annuity-equivalent cost of each model?
4. Which model should the company purchase? Explain.
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