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CMA Final · Strategic Cost Management · Asset Life Cycle Costing

Machine P costs Rs 5,00,000, has annual running cost of Rs 1,00,000 for 4 years and no salvage. Machine Q costs Rs 4,00,000, with annual running cost Rs 1,50,000 for 3 years and no salvage. Rate is 10%. Annuity factors: 3 years 2.4869, 4 years 3.1699. Which machine is preferable using equivalent annual cost?

Machine P is preferable. Its equivalent annual cost is about Rs 2,57,750 against about Rs 3,10,850 for Machine Q. Because the lives differ, present values must be annualised by dividing by each annuity factor before comparison.

  1. AMachine Q, EAC about Rs 3,10,000
  2. BMachine P, EAC about Rs 2,57,000Correct
  3. CMachine P, EAC about Rs 3,17,000
  4. DMachine Q, EAC about Rs 2,61,000

Explanation

P: PV = 5,00,000 + 1,00,000 x 3.1699 = 8,16,990; EAC = 8,16,990/3.1699 = 2,57,750. Q: PV = 4,00,000 + 1,50,000 x 2.4869 = 7,73,035; EAC = 7,73,035/2.4869 = 3,10,850. P has lower EAC. Comparing raw PVs would wrongly favour Q because lives differ.

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