Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $197,000, has a 3-year life, and has pretax operating costs of $37,000 per year. The Techron II costs $294,000, has a 6-year life, and has pretax operating costs of $26,000 per year. For both milling machines, use straight-line depreciation to zero over the project's life and assume a salvage value of $20,000. If your tax rate is 34 percent and your discount rate is 15 percent. The Techron I has an EAC of $( ) , while the Techron II has an EAC of $ ( )You prefer Techron I or II?

Answer 1

Techron I:

Cost of Machine = $197,000
Useful Life = 3 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $197,000 / 3
Annual Depreciation = $65,666.67

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$37,000 * (1 - 0.34) + 0.34 * $65,666.67
Annual OCF = -$2,093.3322

Salvage Value = $20,000

After-tax Salvage Value = $20,000 * (1 - 0.34)
After-tax Salvage Value = $13,200

NPV = -$197,000 - $2,093.3322 * PVIFA(15%, 3) + $13,200 * PVIF(15%, 3)
NPV = -$197,000 - $2,093.3322 * 2.28323 + $13,200 * 0.65752
NPV = -$193,100.295

EAC = NPV / PVIFA(15%, 3)
EAC = -$193,100.295 / 2.28323
EAC = -$84,573.30

Techron II:

Cost of Machine = $294,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $294,000 / 6
Annual Depreciation = $49,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$26,000 * (1 - 0.34) + 0.34 * $49,000
Annual OCF = -$500

Salvage Value = $20,000

After-tax Salvage Value = $20,000 * (1 - 0.34)
After-tax Salvage Value = $13,200

NPV = -$294,000 - $500 * PVIFA(15%, 6) + $13,200 * PVIF(15%, 6)
NPV = -$294,000 - $500 * 3.78448 + $13,200 * 0.43233
NPV = -$290,185.484

EAC = NPV / PVIFA(15%, 6)
EAC = -$290,185.484 / 3.78448
EAC = -$76,677.77

So, you should prefer Techron II as its EAC is lower than that of Techron I