A five-year project has an initial fixed asset investment of $260,000, an initial NWC investment of...

A five-year project has an initial fixed asset investment of $260,000, an initial NWC investment of $20,000, and an annual OCF of -$19,000. The fixed asset is fully depreciated over the life of the project and has no salvage value.

If the required return is 10%, what is this project's equivalent annual cost, or EAC?

Solutions

Expert Solution

Initial Investment

Initial Investment = initial fixed asset investment + Net Working Capital

= $260,000 + $20,000

= $280,000

Cash flow Year 1 to Year 4 = -$19,000

Cash Flow Year 5 = Operating Cash Flow + Release of Net Working Capital

= -$19,000 + $20,000

= $1,000

Net Present Value

Year	Annual Cash Flow	Present Value factor at 10%	Present Value of Cash Flow

1	-19,000.00	0.90909	-17,272.73
2	-19,000.00	0.82645	-15,702.48
3	-19,000.00	0.75131	-14,274.98
4	-19,000.00	0.68301	-12,977.26
5	1,000.00	0.62092	620.92

TOTAL		3.79079	-59,606.52

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= -$59,606.52 - $280,000

= -$3,39,606.52 (Negative NPV)

Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) = Net Present Value / (PVIFA 10%, 5 Years)

= -$3,39,606.52 / 3.79079

= -$89,587.35 (Negative)

“Therefore, the Projects Equivalent Annual Cost (EAC) would be -$89,587.35 (Negative)”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

jeff jeffy answered 1 year ago

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