Question

Bridgton Golf Academy is evaluating new golf practice equipment. The "Dimple-Max" equipment costs $116,000, has a 6-year life, and costs $9,300 per year to operate. The relevant discount rate is 10 percent. Assume that the straight-line depreciation method is used and that the equipment is fully depreciated to zero. Furthermore, assume the equipment has a salvage value of $8,700 at the end of the project’s life. The relevant tax rate is 21 percent. All cash flows occur at the end of the year. What is the equivalent annual cost (EAC) of this equipment? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Equivalent Annual Cost (EAC) for the Equipment

Annual Operating cash flow (OCF)

Annual Operating cash flow (OCF) = [Annual costs x (1 – Tax rate)] + [Depreciation x Tax rate]

= [-$9,300 x (1 – 0.21)] + [($116,000/6 Years) x 0.21]

= [-$9,300 x 0.79] + [$19,333.33 x 0.21]

= -$7,347.00 + $4,060.00

= -$3,287.00 (Negative OCF)

After-tax salvage value

After-tax salvage value = Salvage value x (1 – Tax rate)

= $8,700 x (1 – 0.21)

= $8,700 x 0.79

= $6,873

Net Present Value

Year	Annual cash flows ($)	Present Value Factor (PVF) at 10.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	(3,287.00)	0.909091	(2,988.18)
2	(3,287.00)	0.826446	(2,716.53)
3	(3,287.00)	0.751315	(2,469.57)
4	(3,287.00)	0.683013	(2,245.07)
5	(3,287.00)	0.620921	(2,040.97)
6	3,586.00 [-$3,287 + $6,873]	0.564474	2,024.20
TOTAL	4.355261	(10,436.11)

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= -$10,436.11 - $116,000

= -$126,436.11 (Negative)

Equivalent Annual Cost (EAC) for the Equipment

Equivalent Annual Cost (EAC) = Net Present Value / [PVIFA 10%, 6 Years]

= -$126,436.11 / 4.355261

= -$29,030.66 (Negative EAC)

Therefore, the Equivalent Annual Cost (EAC) for the Equipment will be -$29,030.66 (Negative EAC)

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.