Question

ou are evaluating two different silicon wafer milling machines. The Techron I costs $267,000, has a 3-year life, and has pretax operating costs of $72,000 per year. The Techron II costs $465,000, has a 5-year life, and has pretax operating costs of $45,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $49,000. If your tax rate is 23 percent and your discount rate is 13 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

Answer : Calculation of EAC of both the machines :

Techron 1

EAC = Net Present Value of Techron / PVAF @ 13% for 3 years.

Net Present value = -Initial Investment + Present value of Operating cash Flows

Annual Operating Cash Flows = - Annual Pre tax operating cost * (1 - tax rate) + Tax shield on Depreciation

= - 72000 * ( 1 - 0.23) + [(267000 / 3 ) * 0.23]

= -55440 + [89000 * 0.23]

= -55440 + 20470

= -34970

After Tax Salvage Value = Salvage Value * (1 - Tax rate)

= 49000 * (1 - 0.23)

= 37730

Present value of Operating Cash Flows = (Annual Operating Cash Flows * PVAF@13% for 3 years) + (After Tax salvage Value * PVF @13% for year 3)

= (-37730 * 2.36115259785 ) + (37730 * 0.69305016227)

= - 62937.5048944

Net Present value = -267000 - 62937.5048944 = -329937.504894

EAC = -329937.504894 / PVAF @ 13% for 3 years

= -329937.504894 / 2.36115259785

=(-$139,735.78)

Techron 2

EAC = Net Present Value of Techron / PVAF @ 13% for 5 years.

Net Present value = -Initial Investment + Present value of Operating cash Flows

Annual Operating Cash Flows = - Annual Pre tax operating cost * (1 - tax rate) + Tax shield on Depreciation

= - 45000 * ( 1 - 0.23) + [(465000 / 5 ) * 0.23]

= -34650 + [ 93000 * 0.23]

= -34650 + 21390

= -13260

After Tax Salvage Value = Salvage Value * (1 - Tax rate)

= 49000 * (1 - 0.23)

= 37730

Present value of Operating Cash Flows = (Annual Operating Cash Flows * PVAF@13% for 5 years) + (After Tax salvage Value * PVF @13% for year 5)

= (-13260 *  3.51723126151) + (37730 * 0.54275993599)

= - 26160.1541427

Net Present value = -465000 - 26160.1541427 = -491160.154142

EAC = -491160.154142 / PVAF @ 13% for 5 years

= -491160.154142 / 3.51723126151

=(-$139,643.97)

Techron 2 is better as it has lower EAC.