Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $258,000, has a three-year life, and has pretax operating costs of $69,000 per year. The Techron II costs $450,000, has a five-year life, and has pretax operating costs of $42,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $46,000. If your tax rate is 35 percent and your discount rate is 9 percent, compute the EAC for both machines. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EAC Techron I $ Techron II $ Which machine do you prefer? Techron II Techron I

Answer 1

Techron I:

Depreciation = Initial cost/useful life = $ 258,000 /3 = $ 86,000

After tax salvage value = $ 46,000 x (1- 0.35) = $ 46,000 x 0.65 = $ 29,900

Operating cash flow = After-tax operating cash flow + tax saving on depreciation

                                = -$ 69,000 x (1 – 0.35) + $ 86,000 x 0.35

                                = - $ 69,000 x 0.65 + $ 30,100 = $ 30,100 - $ 44,850 = - $ 14,750

Computation of NPV:

Year	Cash Flow(C)	PV Factor calculation	PV Factor @ 9 %(F)	PV (= C x F)
0	-$ 258,000	1/(1+9%)^0	1	-$258,000.00
1	-$ 14,750	1/(1+9%)^1	0.917431193	-$13,532.11
2	-$ 14,750	1/(1+9%)^2	0.841679993	-$12,414.78
3	*$ 15,150	1/(1+9%)^3	0.77218348	$11,698.58
			NPV	-$272,248.31

*$ 15,150 = -$ 14,750 + $ 29,900

EAC = NPV/(PVIFA, r, n)

        = - $ 272,248.31/(PVIFA, 9 %, 3)

        = - $ 272,248.31/ 2.5313 = - $ 107,552.76

Techron II:

Depreciation = Initial cost/useful life = $ 450,000 /5 = $ 90,000

After tax salvage value = $ 29,900

Operating cash flow = After-tax operating cash flow + tax saving on depreciation

                                = -$ 42,000 x (1 – 0.35) + $ 150,000 x 0.35

                                = - $ 42,000 x 0.65 + $ 31,500 = $ 31,500 - $ 27,300 = $ 4,200

Computation of NPV:

Year	Cash Flow (C)	PV Factor calculation	PV Factor @ 9 % (F)	PV (= C x F)
0	- $ 450,000	1/(1+9%)^0	1	($450,000.00)
1	$ 4,200	1/(1+9%)^1	0.917431193	$3,853.21
2	$ 4,200	1/(1+9%)^2	0.841679993	$3,535.06
3	$ 4,200	1/(1+9%)^3	0.77218348	$3,243.17
4	$ 4,200	1/(1+9%)^4	0.708425211	$2,975.39
5	**$34,100	1/(1+9%)^5	0.649931386	$22,162.66
			NPV	-$414,230.52

**$ 34,100 = $ 4,200 + $ 29,900

EAC = NPV/ (PVIFA, r, n)

      = - $ 272,248.31 /(PVIFA, 9 %, 5)

     = - $ 272,248.31/ 3.8897 = - $ 106,494.21

Techron II is preferable as EAC for Techron II is less than Techron I