Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $264,000, has a three-year life, and has pretax operating costs of $71,000 per year. The Techron II costs $460,000, has a five-year life, and has pretax operating costs of $44,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $48,000. If your tax rate is 23 percent and your discount rate is 8 percent, compute the EAC for both machines. (Your answer should be a negative value and indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Which machine should you choose? Techron II Techron I

Answer 1

We can calculate the desired result as follows:

For Techron I Macine:

Initial Cash Outflows (Year 0)	$ 264,000
Cash Flows during year 1 - 3
Pretax operating cost	($ 71,000)
Depreciation (264,000 / 3)	($ 88,000)
Profit before Tax	($159,000)
Less: Tax @ 23%	$ 52,470
PAT	($106,530)
Add: Depreciation	$ 88,000.00
Cash flow after tax	($18,530.00)
Terminal Cash Flow (year 3)
Salvage Value	$ 48,000
Profit on sale	$ 48,000
Less: Tax @23%	$ 11,040
Net Salvage Vale (48,000-11,040)	$ 36,960
Net Cash flow during year 3 ( 36,960 - 18,530)	$ 18,430

For Techron II Macine:

Initial Cash Outflows (Year 0)	$ 460,000
Cash Flows during year 1 - 5
Pretax operating cost	($ 44,000)
Depreciation (460,000 / 5)	($ 92,000)
Profit before Tax	($136,000)
Less: Tax @ 23%	$ 31,280
PAT	($104,720)
Add: Depreciation	$ 92,000.00
Cash flow after tax	($12,720.00)
Terminal Cash Flow (year 5)
Salvage Value	$ 48,000
Profit on sale	$ 48,000
Less: Tax @23%	$ 11,040
Net Salvage Vale (48,000-11,040)	$ 36,960
Net Cash flow during year 3 ( 36,960 - 12,720)	$ 24,240

EAC for both machines is as follows:

EAC = NPV / (1 - (1 + r) ^ n) / r

Formulas used in the excel sheet are:

Techron I should be selected as it has lesser negative EAC than Techron II.