Equivalent Annual Cost
A- A manufacturer is considering replacing an existing autoclave that nears the end of its useful life and no longer provides the required pressure with a new one. The new autoclave will be used in production of highly specialized composite parts that the company is supplying to the aircraft industry. In choosing the new autoclave, the company has two opportunities. Both produce same quality of finished produce, but differ in annual maintenance costs, initial price, and longevity. Autoclave A costs US$1.5M to buy and install, requires $240,000 in annual maintenance expense over its useful life of 6 years, and can be depreciated to its salvage value of zero using straight-line method. Autoclave B costs US$2.2M to buy and install, requires $120,000 in annual maintenance expense, but has a useful life of 10 years. It is also depreciated using straight-line method and has no salvage value at the end of its life. What alternative should the company choose? The company’s weighted average cost of capital is 10% and its marginal rate of income tax is 35%.
B- Assume that the life of Autoclave A can be extended for an extra two years, at which time the maintenance costs will increase to $350,000 per year. How will this affect the comparison of the alternatives?