Question

A seven-year project has an initial investment of $550,000 and an annual operating cost of $32,000 in the first year. The operating costs are expected to increase at the rate of inflation, which is projected at 2% for the life of the project. The investment is in Class 7 for CCA purposes, and will therefore be depreciated at 15% annually. The salvage value at the end of the project will be $98,000. The firm’s discount rate is 11%, and the company falls in the 35% tax bracket. What is the EAC for the investment?

Answer 1

Post tax salvage value =98000*(1-35%)=			63700
	a	b	c	d.	e
Year	Investment	Operating cost with 2% YOY inflation	Depreciation @15%	Depreciation Tax shield =c*35%	Post Tax salvage value	Net Cost=a+b-d-e	Discount factor @11%=1/1.11^n	PV of Net Cost
Year 0	$    550,000.00					$        550,000.00	1.000	$ 550,000.00
Year 1		$      32,000.00	$    82,500.00	$     28,875.00		$            3,125.00	0.901	$     2,815.63
Year 2		$      32,640.00	$    82,500.00	$     28,875.00		$            3,765.00	0.812	$     3,057.18
Year 3		$      33,292.80	$    82,500.00	$     28,875.00		$            4,417.80	0.731	$     3,229.41
Year 4		$      33,958.66	$    82,500.00	$     28,875.00		$            5,083.66	0.659	$     3,350.13
Year 5		$      34,637.83	$    82,500.00	$     28,875.00		$            5,762.83	0.593	$     3,417.36
Year 6		$      35,330.59	$    82,500.00	$     28,875.00		$            6,455.59	0.535	$     3,453.74
Year 7		$      36,037.20	$    55,000.00	$     19,250.00	$   63,700.00	$        (46,912.80)	0.482	$ (22,611.97)
						Total	5.713	$ 546,711.47
Annuity factor @11% for 7 years is 5.713
EAC =PV of net cost /Annuity factor=546711.47/5.713=				$     95,696.04
	So the EAC is	$      95,696.04