Question 1

Section A

DeepSea Minerals PLC is evaluating two mutually exclusive underwater extraction machines with different useful lives. Machine X costs $400,000, has a 3-year life, and an NPV of costs of $520,000. Machine Y costs $550,000, has a 5-year life, and an NPV of costs of $710,000. The company's cost of capital is 10%.

What is the Equivalent Annual Cost (EAC) of Machine Y? (Annuity factor for 10% at 5 years is 3.791)

Accepted Answer

Use the formula for Equivalent Annual Cost (EAC) = Present Value of Total Costs / Annuity Factor for the life of the asset.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Dividing only the initial capital cost by the annuity factor, forgetting that the NPV of costs already includes the initial cost and running costs.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 6

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