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Chapter 5

Question 4

EAC

A decision must be made on a replacement policy for a fleet of cars. A car
costs $20,000 and the following additional information applies:
Sales value at end of year: 1 $12,000 2 $10,000 3 $6,000

Maintenance costs in year: 1 $1,500 2 $2,300 3 $4,000
Calculate the optimal replacement cycle for the machine if the cost of capital is
14%.

1 year cycle

t0 (20,000) × 1 = (20,000)

t1 [(1,500) + 12,000] × 0.877 = 9,209

Total PV of cycle = $(10,791)

EAC = (10,791)/0.877 = $(12,304)

2 year cycle

t0 (20,000) × 1 = (20,000)

t1 (1,500) × 0.877 = (1,316)

t2 [(2,300) + 10,000] × 0.769 = 5,921

Total PV of cycle = $(15,395)

EAC = (15,395)/1.647 = $(9,347)

3 year cycle

t0 (20,000) × 1 = (20,000)

t1 (1,500) × 0.877 = (1,316)

t2 (2,300) × 0.769 = (1,769)

t2 [(4,000) + 6,000] × 0.675 = 1,350

Total PV of cycle = $(21,735)

EAC = (21,735)/2.322 = $(9,360)

The 2 year cycle is the cheapest option.

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