2024/04/25

Financial Management 332

COMPONENT 5:
EQUIVALENT UNIFORM ANNUAL
COST (EUAC)

Economic and Management Sciences | EyeNzululwazi ngoQoqosho noLawulo | Ekonomiese en Bestuurswetenskappe

CLASS PROBLEM 2

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FasterTrucks Ltd is a transport company. The enterprise needs

to decide if a new delivery vehicle will be purchased. Two
models are currently considered. You are required to indicate
which one of the two models should be purchased.

You decide to apply the Equivalent Uniform Annual Cost

method. Since the economic lifetimes of the two models
differ, you will have to apply the replacement chain
approach. Assume that the company’s cost of capital
amounts to 10% per year. The following information is
provided to you

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The purchase price of the vehicle amounts to R150 000 now. Furthermore, the
vehicle needs to be adjusted at a total cost of R30 000 now. The purchase price and
1.1
the cost of adjusting the vehicle are not expected to change during the next ten
years. The vehicle’s expected economic lifetime is estimated as three years.

The annual maintenance cost of the vehicle amounts to R5 000 at the end of the first year,
1.2 and it is expected that the maintenance cost will increase by R300 per year thereafter (each
year in comparison to the immediate preceding year) due to wear-and-tear to the vehicle.

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Theannualinsurancepremiumof the vehicleamountstoR4000peryear(payableatthebeginning

1.3 of the first year), and it is expected that the annual insurance premiums will decrease by 2% per
year (each year in comparison to immediatelypreceding year) due to wear-and-tear to the vehicle.

The expected after-tax sales proceeds of the vehicles at the end of each three-year
1.4 economic lifetime cycle amounts to R70 000.

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TOTAL EUAC : MODEL 1 = – R 60 831,70 p.a.

The purchase price amounts to R170 000 now. Due to inflation, it is expected that the
2.1 vehicle’s replacement cost will increase by 3% per year. The expected economic lifetime
of the vehicle is two years, and straight-line depreciation is provided over this period.

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The annual maintenance cost of the vehicle amounts to R6 000 per year, and it is not
2.2 expected that this cost will change during the next ten years.

PMT = – R6 000

The annual insurance, payable in arrears, of the vehicle amounts to R7 500 per year, and
2.3 the insurance premiums are not expected to change during the next ten years.

PMT = – R7 500

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The expected after-tax sales proceeds of the vehicles at the end of each economic lifetime
2.4 cycle of two years amount to 10% of their purchase prices at the beginning of the cycle.

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TOTAL EUAC : MODEL 2 = – R 108 228,90 p.a.

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TOTAL EUAC : MODEL 1 = – R 60 831,70 p.a.

TOTAL EUAC : MODEL 2 = – R 108 228,90 p.a.
WOULD THEREFORE RECOMMEND THAT THE COMPANY PURCHASE MODEL 1,
SINCE IT IS SIGNIFICANTLY LESS EXPENSIVE THAN MODEL 2.

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