Ambuja University must purchase word processors that cost INR 8,000 each and have annual, year-end maintenance costs of INR 2,000 per machine. The EVF word processors will be replaced at the end of year 4 and have no value at that time.
Alternatively, Ambuja can buy 11 AEH word processors to accomplish the same work. The AEH word processors will be replaced after three years.They each costs INR 5,000 and have annual, year-end maintenance costs of 2,500 per machine.
Each AEH word processor will have a resale value of INR 500 at the end of three years.
The university's opportunity cost of funds for this type of investment is 14 percent. Because the university is a nonprofit institution, it does not pay taxes.
It is anticipated that whichever manufacturer is chosen now will be the supplier of future machines.
Would you recommend purchasing 10 EVF word processors or 11 AEH machines?
Please refer attached file for better clarity of tables and formulas.
Let us first find NPV for EVF word processors
Cost 10 units @ INR 8000 each=80000 INR
Annual maintenance cost @ INR 2000 each= 20000 INR
Value at the end of 4th year=0 INR
Useful life=4 years
Year End Cost Maintenance Net Cash Flow PV @14%
0 -80000 -80000 80000/1.14^0=-80000
1 -20000 -20000 20000/1.14^1=-17544
2 -20000 -20000 ...
Solution describes the steps for choosing an investment alternative based upon equivalent annual cost method.