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Good day
I have just studied the section regarding the optimum replacement period for assets, where the NPV of each option (with different time periods) is divided by the annuity discount factor (using the same cost of capital rate that was used to calculate NPV) to obtain the equivalent annual cost, so that the options are comparable.
However, in a different tuition provider’s study text, the NPV of each option was simply divided by the number of years the asset is in use, instead of using the annuity discount factor.
I am not sure which method should be followed in the exams. Although the result is likely to be the same (which project costs MORE or LESS), but if we are asked to calculate the comparable annual cost for each option, which method should be followed? Since it would give slightly different answers.
I hope that you can shed some light on this issue.
Kind regards,
CarineHi, Ithanksfor your question -eAC using the annuity factor is the conventionak way to calculate this – Ive never heard of another method- think if you check other sources – eg Kaplan knowledge /formulae bank (link below) you’ll see the formulae is shown using annuity rates. So I recommend using that version (same as our notes)
. Hope that helps
Kind Regards
CathHi Cath
Great, thanks for your response, I will follow your advice to rather use the EAC method. Thanks for clearing it up.
Kind Regards,
Carine
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