Question

A five-year project has an initial fixed asset investment of $325,000, an initial NWC investment of $33,000, and an annual OCF of -$32,000. The fixed asset is fully depreciated over the life of the project and has no salvage value. If the required return is 11 percent, what is this project’s equivalent annual cost, or EAC? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Project’s Equivalent Annual Cost (EAC)

Initial Investment for the Project

Initial Investment for the Project = Cost of the asset + Investment in Net Working capital

= $325,000 + $33,000

= $358,000

Annual Net Cash flow for the next 5 years

Year 1-4 Annual Cash flow = -$32,000

Year 5 Cash flow = Annual operating cash flow + Release of net working capital

= -$32,000 + $33,000

= $1,000

Net Present Value of the Project

Period	Annual Cash Flow ($)	Present Value factor at 11%	Present Value of Cash Flow ($)
1	-32,000	0.900901	-28,828.83
2	-32,000	0.811622	-25,971.92
3	-32,000	0.731191	-23,398.12
4	-32,000	0.658731	-21,079.39
5	1,000	0.593451	593.45
TOTAL		3.695897	-98,684.81

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

= -$98,684.81 - $358,000

= -$4,56,684.81 (Negative NPV)

Project’s Equivalent Annual Cost (EAC)

Project’s Equivalent Annual Cost (EAC) = Net Present Value / (PVIFA 11%, 5 Years)

= -$456,684.81 / 3.695897

= -$123,565.35 (Negative)

“Hence, the Project’s Equivalent Annual Cost (EAC) would be -$123,565.35 (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.