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CA Final · Advanced Financial Management · Advanced Capital Budgeting Decisions

Himalaya Engineering must choose between two machines for a continuing need, with a cost of capital of 10%. Machine A costs ₹3,00,000, lasts 3 years and has annual operating cost of ₹60,000. Machine B costs ₹4,50,000, lasts 5 years and has annual operating cost of ₹40,000. PV annuity factors at 10%: 3 years 2.4869, 5 years 3.7908. Which choice is correct?

Machine B should be chosen. With unequal lives, the equivalent annual cost is the right comparison: about ₹1,58,709 for B against ₹1,80,632 for A. Comparing total present value of costs would wrongly favour A because it covers a shorter period.

  1. AChoose Machine A, as its PV of cost of ₹4,49,214 is lower than Machine B's
  2. BChoose Machine A, as its equivalent annual cost is ₹1,80,632
  3. CChoose Machine B, as its PV of cost of ₹6,01,632 is the relevant measure
  4. DChoose Machine B, as its equivalent annual cost is about ₹1,58,709 against ₹1,80,632 for ACorrect

Explanation

Lives are unequal, so use equivalent annual cost. A: 3,00,000/2.4869 = 1,20,632 + 60,000 = 1,80,632. B: 4,50,000/3.7908 = 1,18,709 + 40,000 = 1,58,709. B is cheaper per year. Comparing raw PV of costs (4,49,214 vs 6,01,632) wrongly favours A because B serves a longer period.

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