Question

Q1.

Amazing Manufacturing, Inc., has been considering the purchase of a new manufacturing facility for $450,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value at that time. Operating revenues from the facility are expected to be $365,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 4 percent. Production costs at the end of the first year will be $210,000, in nominal terms, and they are expected to increase at 5 percent per year. The real discount rate is 7 percent. The corporate tax rate is 21 percent.

   

Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Q2.

You are evaluating two different silicon wafer milling machines. The Techron I cost $270,000, has a 3-year life, and has pretax operating costs of $73,000 per year. The Techron II costs $470,000, has a 5-year life, and has pretax operating costs of $46,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $50,000. If your tax rate is 24 percent and your discount rate is 10 percent, compute the EAC for both machines. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Which machine do you prefer?

Techron I Techron II

Answer 1

NPV with Real cash flows
Year	0	1	2	3	4	5	6	7
Purchase cost	-450000
Operating revenues at t=0 $ values(365000/1.04)		350961.54	350961.54	350961.54	350961.54	350961.54	350961.54	350961.54
Production costs at t=0 $ values(210000/1.05)		-200000.00	-200000.00	-200000.00	-200000.00	-200000.00	-200000.00	-200000.00
Depn.(450000/7)		-64285.71	-64285.71	-64285.71	-64285.71	-64285.714	-64285.71	-64285.71
EBT		86675.82	86675.82	86675.82	86675.82	86675.82	86675.82	86675.82
Tax at 21%(EBT*21%)		-18201.92	-18201.92	-18201.92	-18201.92	-18201.92	-18201.92	-18201.92
EAT/NOPAT		68473.90	68473.90	68473.90	68473.90	68473.90	68473.90	68473.90
Add back: depn.		64285.71	64285.71	64285.71	64285.71	64285.71	64285.71	64285.71
Opg. Real Cash flows		132759.62	132759.62	132759.62	132759.62	132759.62	132759.62	132759.62
Total annual Real FCFs	-450000	132759.62	132759.62	132759.62	132759.62	132759.62	132759.62	132759.62
PV F at 7%(1/1.07^ Yr.n)	1	0.93458	0.87344	0.81630	0.76290	0.71299	0.66634	0.62275
PV at 7%	-450000	124074.41	115957.39	108371.39	101281.67	94655.77	88463.34	82676.02
NPV at 7%	265479.99	(Answer)

2.EAC= NPV of costs/ Annuity Factor
So, we will calculate the NPV of costs
	Techron I	Techron II
Initial cost	-270000	-470000
PV of After-tax operating costs :
73000*(1-24%)*2.48685	-137970.44
P/A,i=10%,n=3 yrs.---2.48685
46000*(1-24%)*3.79079		-132526.02
PV of Depn. Tax shields
270000/3*24%*2.48685	53715.96
470000/5*24%*3.79079		85520.22
PV of after-tax Salvage value
50000*(1-24%)/1.1^3=	28549.96
50000*(1-24%)/1.1^5=		23595.01
Net PV of costs-------a	-325704.52	-493410.79
Equivalent annual cost=
NPV of costs/PV Factor
NPV Factor---------b	2.48685	3.79079
EAC----------------a/b	-130970.71	-130160.41

Based on EAC ,Techron II is preferred .

Its EAC is LESS than that for Techron I