Question

Question #2: Which Should We Buy?

• Using the EAC approach, which machine should we choose? Use the table below to plan your cash flows (Bold boxes are where #’s should be).
• Neither machine will have a differential impact on revenue. No change in NWC is required. The straight line depreciation rate is 20%, the required return is 10% and the tax rate is 40%. There is no salvage values for either machine.

	Machine A	Machine B
Initial Cost	$150,000	$100,000
Pre-Tax Operating Cost	$65,000	$57,500
Expected Life (years)	8	5

Machine A: Cash Flows
Year	PV	0	1	2	3	4	5	6	7	8
OCF
Initial Cost
Total Cash Flows
Depreciation Tax Shield (Benefit)
NPV
EAC

Answer 1

As per the information given in the question, answer is as below :

Machine A
Year	PV	0	1	2	3	4	5	6	7	8
Initial Cost	$       (150,000)	$       (150,000)	$                   -	$             -	$             -	$             -	$             -	$             -	$             -	$             -
OCF	$       (346,770)	$                     -	$       (65,000)	$ (65,000)	$ (65,000)	$ (65,000)	$ (65,000)	$ (65,000)	$ (65,000)	$ (65,000)
Shield (Benefit)	$          138,708	$                     -	$         26,000	$   26,000	$   26,000	$   26,000	$   26,000	$   26,000	$   26,000	$   26,000
Depreciation Tax	$            45,489	$                     -	$         12,000	$   12,000	$   12,000	$   12,000	$   12,000	$             -	$             -	$             -
Total Cash Flow	$       (312,573)	$       (150,000)	$       (27,000)	$ (27,000)	$ (27,000)	$ (27,000)	$ (27,000)	$ (39,000)	$ (39,000)	$ (39,000)
NPV	5.3349	-	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645	0.5132	0.4665
EAC	$          (58,590)

Machine B
Year	PV	0	1	2	3	4	5
Initial Cost	$       (100,000)	$       (100,000)	$                   -	$             -	$             -	$             -	$             -
OCF	$       (217,970)	$                     -	$       (57,500)	$ (57,500)	$ (57,500)	$ (57,500)	$ (57,500)
Shield (Benefit)	$            87,188	$                     -	$         23,000	$   23,000	$   23,000	$   23,000	$   23,000
Depreciation Tax	$            30,326	$                     -	$            8,000	$      8,000	$      8,000	$      8,000	$      8,000
Total Cash Flow	$       (200,456)	$       (100,000)	$       (26,500)	$ (26,500)	$ (26,500)	$ (26,500)	$ (26,500)
NPV	3.7908	-	0.9091	0.8264	0.7513	0.6830	0.6209
EAC	$    (52,879.75)

Since EAC of Machine B is lower, hence Machine B should be selected.