Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $276,000, has a 3-year life, and has pretax operating costs of $75,000 per year. The Techron II costs $480,000, has a 5-year life, and has pretax operating costs of $48,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $52,000. If your tax rate is 21 percent and your discount rate is 12 percent, compute the EAC for both machines.

Answer 1

EAC: PV of CFs today / PVAF (r%, n)

Techron1:

Post Tax op COst = Pre Tax OP Cost * ( 1 - Tax rate )

= 75000 ( 1 - 0.21 )

= 75000 * 0.79

= $ 59250

Tax Shield on Dep = Dep * tax rate

Dep = [ Cost - Salvage Value ] /Life

= [ 276000 - 0] / 3

= 92000

Tax Shield on Dep = Dep * tax rate

= 92000 * 21%

= 19320

After Tax Salvage Value :

= Salvage Value * ( 1 - Tax rate )

= 52000 ( 1 - 0.21 )

= 52000 * 0.79

= 41080

EAC:

Incomeing CFs are displayed with -ve sign

Year	Cost	Post Tax Cost	Tax shield on Dep	Salvage Value	CF	PVF @12%	Disc CF
0	$ 2,76,000.00				$ 2,76,000.00	1.0000	$ 2,76,000.00
1		$ 59,250.00	$ -19,320.00		$    39,930.00	0.8929	$    35,651.79
2		$ 59,250.00	$ -19,320.00		$    39,930.00	0.7972	$    31,831.95
3		$ 59,250.00	$ -19,320.00	$ -41,080.00	$     -1,150.00	0.7118	$        -818.55
PV of Net Cash Outflows	$ 3,42,665.19
PVAF (r%,n)	2.4018
EAC	$ 1,42,670.16

Techron1:

Post Tax op COst = Pre Tax OP Cost * ( 1 - Tax rate )

= 48000 ( 1 - 0.21 )

= 48000 * 0.79

= $ 37920

Tax Shield on Dep = Dep * tax rate

Dep = [ Cost - Salvage Value ] /Life

= [ 480000 - 0] / 3

= 160000

Tax Shield on Dep = Dep * tax rate

= 160000 * 21%

= 33600

After Tax Salvage Value :

= Salvage Value * ( 1 - Tax rate )

= 52000 ( 1 - 0.21 )

= 52000 * 0.79

= 41080

Year	Cost	Post Tax Cost	Tax shield on Dep	Salvage Value	CF	PVF @12%	Disc CF
0	$ 4,80,000.00				$ 4,80,000.00	1.0000	$ 4,80,000.00
1		$ 37,920.00	$ -33,600.00		$      4,320.00	0.8929	$       3,857.14
2		$ 37,920.00	$ -33,600.00		$      4,320.00	0.7972	$       3,443.88
3		$ 37,920.00	$ -33,600.00		$      4,320.00	0.7118	$       3,074.89
4		$ 37,920.00	$ -33,600.00		$      4,320.00	0.6355	$       2,745.44
5		$ 37,920.00	$ -33,600.00	-41080	$ -36,760.00	0.5674	$   -20,858.61
PV of Net Cash Outflows	$ 4,72,262.74
PVAF (r%,n)	3.6048
EAC	$ 1,31,010.28

Pls do rate, if the answer is correct and comment, if any further assistance is required.