Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $261,000, has a 3-year life, and has pretax operating costs of $70,000 per year. The Techron II costs $455,000, has a 5-year life, and has pretax operating costs of $43,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $47,000. If your tax rate is 21 percent and your discount rate is 11 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 II

Techron I

Answer 1

Techron I

Time line		0	1	2	3
Cost of new machine		-261000
=Initial Investment outlay		-261000
						100.00%
Sales			0	0	0
Profits	Sales-variable cost		0	0	0
Operating cost			-70000	-70000	-70000
-Depreciation	Cost of equipment/no. of years		-87000	-87000	-87000	0	=Salvage Value
=Pretax cash flows			-157000	-157000	-157000
-taxes	=(Pretax cash flows)*(1-tax)		-124030	-124030	-124030
+Depreciation			87000	87000	87000
=after tax operating cash flow			-37030	-37030	-37030
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				37130
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					37130
Total Cash flow for the period		-261000	-37030	-37030	100
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor	-261000	-33360.3604	-30054.38	73.119138
NPV=	Sum of discounted CF=	-324341.62

EAC	-132724.8299
Year or period		0	1	2	3
EAC			-132724.83	-132724.8	-132724.8
Discount factor=	(1+discount rate)^corresponding period		1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor		-119571.919	-107722.4	-97047.25
NPV=	-324341.6199
EAC is equivalent yearly CF with same NPV =	-132724.83

Techron II

Time line		0	1	2	3	4	5
Cost of new machine		-455000
=Initial Investment outlay		-455000
								100.00%
Sales			0	0	0	0	0
Profits	Sales-variable cost		0	0	0	0	0
Operating cost			-43000	-43000	-43000	-43000	-43000
-Depreciation	Cost of equipment/no. of years		-91000	-91000	-91000	-91000	-91000	0	=Salvage Value
=Pretax cash flows			-134000	-134000	-134000	-134000	-134000
-taxes	=(Pretax cash flows)*(1-tax)		-105860	-105860	-105860	-105860	-105860
+Depreciation			91000	91000	91000	91000	91000
=after tax operating cash flow			-14860	-14860	-14860	-14860	-14860
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						37130
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							37130
Total Cash flow for the period		-455000	-14860	-14860	-14860	-14860	22270
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704	1.6850582
Discounted CF=	Cashflow/discount factor	-455000	-13387.3874	-12060.71	-10865.5	-9788.742	13216.161
NPV=	Sum of discounted CF=	-487886.18

EAC	-132007.5152
Year or period		0	1	2	3	4	5
EAC			-132007.515	-132007.5	-132007.5	-132007.5	-132007.5
Discount factor=	(1+discount rate)^corresponding period		1.11	1.2321	1.367631	1.5180704	1.6850582
Discounted CF=	Cashflow/discount factor		-118925.689	-107140.3	-96522.76	-86957.44	-78340.04
NPV=	-487886.1819
EAC is equivalent yearly CF with same NPV =	-132007.52

Choose Techtron II as it has higher EAC