ABC Inc is a manufacturing company that needs to purchase new machinery. They have two options, machine A, which costs $24.50 and lasts 11 years, or machine B, which costs $13 and lasts 6 years. The purchase price of each machine reflects the amount that must be paid today. In addition, machine A requires annual maintenance of $1.35 and machine B requires annual maintenance of $2.05. The first maintenance expenditures occur one year from today. The discount rate is 11%. Assume the following, which simplifies the problem and ensures that ABC only cares about the cost of the machine: · Both machines are equally efficient in production. · There is no inflation, and each machine can be purchased for the same price in the future. · ABC Inc will have ongoing needs for the machine. a. Ignoring maintenance, convert the upfront purchase price of each machine into an equivalent annual cost of ownership over the life of the machine. That is, find the payment amount that would make you indifferent between paying that amount each year starting one year from today, and paying the upfront cost. a. Suggestion: Getting this right is crucial. Try solving this using the annuity formula and a financial calculator or excel to make sure you get the same answer.
b. Add maintenance to the annual cost from part (a). This yields the total annual cost of ownership for each machine.
c. Now, use the figures from part (b) to determine which machine provides the better value. Based on this, offer your recommendation of which machine ABC should purchase.
d. Recalculate the total annual cost of each machine assuming that the discount rate is 7%. Does this change your answers in parts (a)-(c)? If so, explain why. How does the interest rate affect the tradeoff between a machine with a high upfront cost and low maintenance, versus one with a low upfront cost and high maintenance?