Question

Please show work

You are evaluating two different silicon wafer milling machines. The Techron I costs $291,000, has a 3-year life, and has pretax operating costs of $80,000 per year. The Techron II costs $505,000, has a 5-year life, and has pretax operating costs of $47,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $57,000. If your tax rate is 21 percent and your discount rate is 13 percent, compute the EAC for both machines. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Which machine do you prefer? Techron I Techron II

Answer 1

The After-tax salvage Value

After-tax salvage value = $45,030 [$57,000 x (1 – 0.21)]

Equivalent Annual Cost (EAC) for Techron I

Operating Cash Flow (OCF)

= Pretax Savings(1 – Tax Rate) + (Depreciation x Tax Rate)

= −$80,000(1 − 0.21) + 0.21($291,000 / 3 Years)

= −$42,830

Net Present Value

Net Present Value = −$291,000 − $42,830[PVIFA13%,3 Years] + $45,030[PVIF 13%, 3 Years]

= −$291,000 – [$42,830 x 2.36115] + [$45,030 x 0.69305]

= -$3,60,920.12 (Negative)

Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) = -$3,60,920.12 / (PVIFA 13%, 3 Years)

= -$3,60,920.12 / 2.36115

= -$1,52,857.60

“Equivalent Annual Cost (EAC) for Techron I = -$1,52,857.60 (Negative)”

Equivalent Annual Cost (EAC) for Techron II

Operating Cash Flow (OCF)

= Pretax Savings(1 – Tax Rate) + (Depreciation x Tax Rate)

= −$47,000(1 − 0.21) + 0.21($505,000 / 5 Years)

= −$15,920

Net Present Value

Net Present Value = −$505,000 − $15,920[PVIFA13%,5 Years] + $45,030[PVIF 13%, 5 Years]

= −$505,000 – [$15,920 x 3.51723] + [$45,030 x 0.54276]

= -$5,36,553.84 (Negative)

Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) = -$5,36,553.84 / (PVIFA 13%, 5 Years)

= -$5,36,553.84 / 3.51723

= -$1,52,550.06 (Negative)

“Equivalent Annual Cost (EAC) for Techron II = -$1,52,550.06 (Negative)”

DECISION

We should prefer the “Techron II” since it has the lower Equivalent Annual Cost (EAC) of -1,52,550.06 as compared with the Equivalent Annual Cost (EAC) of Techron I

“Equivalent Annual Cost (EAC) for Techron I = -$1,52,857.60 (Negative)”

“Equivalent Annual Cost (EAC) for Techron II = -$1,52,550.06 (Negative)”