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Interactive Audio Lesson
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Understanding EAC and Cash Flows
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Today, we're learning about the Equivalent Annual Cost, or EAC. Can anyone tell me what EAC stands for and why it's important?
EAC stands for Equivalent Annual Cost, and it's important because it helps compare costs that occur over different time periods!
Exactly! By converting all costs into an annual figure, we can evaluate and compare total expenses effectively over the lifespan of an asset. Now, let’s look at the purchase price.
So if the purchase price is 3,500,000 and we calculate its EAC, how do we do that?
Great question! We multiply the purchase price by the Uniform Series Capital Recovery Factor. For instance, in Year 3, that factor was found to be 0.4380. Can anyone calculate the EAC for the purchase price?
It's 1,533,000 rupees!
Perfect! EAC for the purchase price is 1,533,000 rupees. This is just one way we analyze costs. Let’s move to operating costs.
Calculating Operating Costs
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Now, can someone explain how we calculate the present worth of operating costs?
We find the present worth factor for the future costs, right?
Exactly! For example, if the operating cost is 113,200 at the end of Year 1, how does that convert to present worth?
We multiply that by the present worth factor, which is 0.8696 for Year 1.
Great work! What’s the calculated present worth?
It’s 98,438.72 rupees.
Now, to determine EAC, we again multiply the present worth by the capital recovery factor. Could someone summarize this method?
We find present worth first, then use the recovery factor to find EAC.
Exactly! You folks are really grasping this.
Including Salvage Value
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Let’s now discuss resale or salvage values. Why is this important when calculating total costs?
Because the salvage value can reduce total cost when we’re replacing a machine!
Exactly! This cash inflow offsets our expenses. For instance, if we sell a machine for 31,50,000, how do we convert that to present value?
We find the present worth factor and multiply!
Right! What about the EAC of that salvage value?
We multiply the present worth by the appropriate capital recovery factor.
Correct! This helps sum up the total EAC, don’t forget to subtract this value from our total costs. In summary, what have we learned about salvage value?
We learned it reduces our total costs!
Beautifully said!
Combining All Costs
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Now, how do we combine our calculated EAC from purchase price, operating costs, and salvage value?
We add the EAC of the purchase price and operating costs, then subtract the salvage value!
That’s right! If our EAC for purchase is 40,25,000 and our operating is 1,13,204.53, and the salvage is 31,50,126, what’s the total EAC?
It would be 9,88,078.53!
Exactly! By continuously applying this process over the economic life of machinery, we can make informed replacement decisions. What’s the key takeaway from our discussion today?
We can evaluate total costs effectively over time!
Fantastic summary!
Introduction & Overview
Read a summary of the section's main ideas. Choose from Basic, Medium, or Detailed.
Quick Overview
Standard
In this section, the various components of total cost calculation are explored, including the equivalent annual cost of purchase price, operating and maintenance costs, and the resale value of the machine. The use of capital recovery factors and present worth factors is emphasized for accurate financial analysis across multiple years.
Detailed
Total Cost Calculation
This section explains how to calculate the Total Cost of ownership, focusing on the Equivalent Annual Cost (EAC) associated with the purchase price, operating and maintenance costs, and the resale value of a machine.
Equivalent Annual Cost (EAC)
The EAC provides a way to compare costs that occur over different time periods. This is essential for making long-term decisions about asset management.
The first step is determining the Cost associated with the purchase price. For instance, using a purchase price of 3,500,000 and a recovery factor for year 3 yields an EAC of 1,533,000 rupees.
Subsequently, the operating and maintenance costs are also converted to present worth to accurately reflect their costs at Year 0. For an operational cost of 113,200 at the end of Year 1, finding its present worth involves using a present worth factor, ultimately allowing us to calculate the EAC of these costs as well.
Through this method, we systematically derive the total cost over all necessary years, accounting for both cash inflows (salvage value) and cash outflows (purchase and operational costs). Finally, the cumulative costs are documented to determine if and when to replace machinery, ultimately aiding in strategic financial decision-making.
Audio Book
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Calculating Equivalent Annual Cost for Purchase Price
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So, now we have to find the equivalent annual cost for the third year of the purchase price 3500000
for year 3,
EAC = 0.4380 × 35,00,000 = 15,33,000 rupees
So like this you are going to calculate for all the years.
Detailed Explanation
In this chunk, we start by calculating the equivalent annual cost (EAC) for the purchase price of a machine, which is 3,500,000 rupees. The first step is to identify the capital recovery factor for the third year, which is given as 0.4380. By multiplying this factor with the total purchase price, we get the equivalent annual cost for that year, which amounts to 1,533,000 rupees. This process is similar for calculating EACs for subsequent years.
Examples & Analogies
Imagine you buy a car for 35,00,000 rupees. Each year, you want to know how much that car costs you in equivalent annual terms to understand your annual budget. Using the EAC, you can have a clearer picture of how much you pay every year based on the car's purchase price.
Finding Present Worth of Operating and Maintenance Costs
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Now let us find the equivalent annual cost of the operating and the maintenance cost. So, how to find the equivalent annual cost let us go back to the cash flow diagram. So, this 1,13,200 is operating and maintenance cost at the end of year 1. Now you convert it into t = 0, how to convert it into t = 0, find the present worth?
So, find the present worth of 1,13,200, so that is a first step. Once you find the present worth of 1,13,200 then you can find its equivalent annual cost using uniform series capital recovery factor.
Detailed Explanation
Here, we focus on the operating and maintenance costs. The cost of operating and maintenance for Year 1 is given as 113,200 rupees. To find this cost's equivalent annual value, we first convert it to its present worth at Year 0. This is done using the appropriate present worth factor. Finding the present worth allows us to understand how much that future payment is worth today. After finding the present worth, we can then calculate the EAC using the capital recovery factor.
Examples & Analogies
Think about a house you own. If you plan to spend 1,13,200 rupees on roof repairs next year, you’d want to know what that future payment means today. By finding the present worth, you can grasp how that future cost compares to your current finances.
Calculating Present Worth Factor
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So, we are going to find the present worth of 1,13,200 that is your operating cost. So, you need to find P for the known F, i, n,
P.W = 0.8696
This present worth factor you multiply it by the operating and maintenance cost.
Present worth value = 0.8696 × 1,13,200 = 98,438.72 rupees
Detailed Explanation
Next, we calculate the present worth factor. Using the formula for the present worth, we find a factor of 0.8696 for 113,200 rupees using a known interest rate and the time period. We then multiply this factor by the operating and maintenance cost to get the present worth value of 98,438.72 rupees. This value represents how much you'd need today to cover that future operating cost.
Examples & Analogies
If you know that your friend owes you 1,13,200 rupees in a year, you would want to know how much money that is worth if you wanted to invest it instead. By calculating the present worth with the factor, you can decide how much you'd rather have now rather than waiting for the payment.
Cumulative Operating and Maintenance Costs
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Now you add the cumulative, so find the cumulative operating and maintenance cost. So, now, next thing is we are going to find the equivalent annual cost of the present worth of the operating and maintenance cost so how to calculate that?
Detailed Explanation
In this step, we calculate the cumulative operating and maintenance cost over multiple years. After finding the present worth for each year, we add these values to get the total cumulative cost. We then look to determine the EAC for this cumulative operating and maintenance cost, which provides us insight into how much these costs would average out annually.
Examples & Analogies
If you were to keep track of all your monthly subscriptions – for maybe a streaming service, gym, and magazine – you’d want to calculate how much those overall costs add up to over the year. It helps you understand your total spending.
Resale Value Calculation
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Now let us find the equivalent annual cost of the resale value, that is your salvage value... First calculate the present value of the resale value... Present worth value = 0.8696 × 31,50,000 = 27,39,240 rupees
Detailed Explanation
We also calculate the equivalent annual cost of the machine's resale value, which is an amount we expect to earn back after using the machine. To find this, we first calculate its present worth using a factor calculated similarly as before. For instance, if the resale value is 3,150,000 rupees, we find its present worth to be 27,39,240 rupees, which gives us a sense of what that future cash inflow is worth today.
Examples & Analogies
If you buy a van for 3,150,000 rupees today and expect to sell it for something back in the future, calculating the present worth helps you understand how much you can save or invest from selling the van in today's terms.
Total Cost Calculation Overview
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So, how to find the total cost? So, you are supposed to add the purchase price and the operating and maintenance cost, your salvage value is in flow cash inflow, so you subtract it.
Detailed Explanation
To find the total equivalent annual cost, we need to add up the equivalent annual costs of both the purchase price and the operating and maintenance costs, while subtracting the expected cash inflow from the resale value. This will give us a complete picture of what it costs to operate and maintain the machine annually along with its initial investment.
Examples & Analogies
Think of it like budgeting for a year. You’ll add your annual rent (purchase price), utility bills (operating and maintenance costs) and then reduce that total by any expected income from subletting your apartment (resale value). This gives you a net annual expense.
Definitions & Key Concepts
Learn essential terms and foundational ideas that form the basis of the topic.
Key Concepts
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EAC: Equivalent Annual Cost provides a unified way to evaluate costs.
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Uniform Series Capital Recovery Factor: Translates present expenses into annual payments.
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Present Worth Factor: Allows us to account for future values in present terms.
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Salvage Value: The cash inflow that offsets costs when the asset is sold.
Examples & Real-Life Applications
See how the concepts apply in real-world scenarios to understand their practical implications.
Examples
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Calculating the EAC for a purchase price of 3,500,000 using a capital recovery factor for Year 3 results in an EAC of 1,533,000 rupees.
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A future operating cost of 113,200 is converted to present value using its factor of 0.8696, resulting in 98,438.72 rupees.
Memory Aids
Use mnemonics, acronyms, or visual cues to help remember key information more easily.
🎵 Rhymes Time
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To find what EAC will be, just multiply, it’s easy to see!
📖 Fascinating Stories
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Imagine you just bought a machine. To know how much it costs each year, you simply find the EAC. Now, every year you're told how much to save, making budgeting a breeze!
🧠 Other Memory Gems
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P.O.S.S.E. - Purchase, Operating Costs, Salvage Value, Summed up for Total EAC.
🎯 Super Acronyms
EAC stands for Every Asset Cost - remember to annualize!
Flash Cards
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Glossary of Terms
Review the Definitions for terms.
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Term: Equivalent Annual Cost (EAC)
Definition:
A method to express total costs over time in an annual format for comparison.
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Term: Uniform Series Capital Recovery Factor
Definition:
A factor used to convert present costs into equivalent annual costs.
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Term: Present Worth Factor
Definition:
A factor used to convert future costs into present value.
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Term: Salvage Value
Definition:
The estimated resale value of an asset at the end of its useful life.