Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $255,000, has a three-year life, and has pretax operating costs of $68,000 per year. The Techron II costs $445,000, has a five-year life, and has pretax operating costs of $41,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $45,000. If your tax rate is 24 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.)

Answer 1

Both cases: After-tax salvage value = SV x (1 - t) = $45,000(1 - 0.24) =$34,200

To calculate the EAC, we need the OCF and NPV of each option.

The OCF and NPV for Techron I is:

OCF = (Sales - Costs)x(1 - t) + Depreciation x t

= -$68,000(1 - 0.24) + 0.24($255,000/3) = -$51,680 + $20,400 = -$31,280

NPV = -$255,000 - $31,280(PVIFA13%,3) + ($34,200/1.13³) = -$305,154.54

EAC = NPV / PVIFA(r%,n) = -$305,154.54 / (PVIFA13%,3) = -$129,239.65

The OCF and NPV for Techron II is:

OCF = (Sales - Costs)x(1 - t) + Depreciation x t

= -$41,000(1 - 0.24) + 0.24($445,000/5) = -$31,160 + $21,360 = -$9,800

NPV = -$445,000 - $9,800(PVIFA13%,5) + ($34,200/1.13⁵) = -$460,906.48

EAC = NPV / PVIFA(r%,n) = -$460,906.48 / (PVIFA13%,5) = -$131,042.41

The two milling machines have unequal lives, so they can only be compared by expressing both on an equivalent annual basis, which is what the EAC method does. Thus, you prefer the Techron I

because it has the lower (Less negative) annual cost.