Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $249,000, has a 3-year life, and has pretax operating costs of $66,000 per year. The Techron II costs $435,000, has a 5-year life, and has pretax operating costs of $39,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $43,000. If your tax rate is 22 percent and your discount rate is 11 percent, compute the EAC for both machines

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Answer 1

Techron I:

Cost of Machine = $249,000
Useful Life = 3 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $249,000 / 3
Annual Depreciation = $83,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$66,000 * (1 - 0.22) + 0.22 * $83,000
Annual OCF = -$33,220

Salvage Value = $43,000

After-tax Salvage Value = $43,000 * (1 - 0.22)
After-tax Salvage Value = $33,540

NPV = -$249,000 - $33,220 * PVIFA(11%, 3) + $33,540 * PVIF(11%, 3)
NPV = -$249,000 - $33,220 * 2.44371 + $33,540 * 0.73119
NPV = -$305,655.9336

EAC = NPV / PVIFA(11%, 3)
EAC = -$305,655.9336 / 2.44371
EAC = -$125,078.64

Techron II:

Cost of Machine = $435,000
Useful Life = 5 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $435,000 / 5
Annual Depreciation = $87,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$39,000 * (1 - 0.22) + 0.22 * $87,000
Annual OCF = -$11,280

Salvage Value = $43,000

After-tax Salvage Value = $43,000 * (1 - 0.22)
After-tax Salvage Value = $33,540

NPV = -$435,000 - $11,280 * PVIFA(11%, 5) + $33,540 * PVIF(11%, 5)
NPV = -$435,000 - $11,280 * 3.69590 + $33,540 * 0.59345
NPV = -$456,785.4390

EAC = NPV / PVIFA(11%, 5)
EAC = -$456,785.4390 / 3.69590
EAC = -$123,592.48