Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $261,000, has a three-year life, and has pretax operating costs of $70,000 per year. The Techron II costs $455,000, has a five-year life, and has pretax operating costs of $43,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $47,000. If your tax rate is 21 percent and your discount rate is 11 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

Techron I:

Cost of Machine = $261,000
Useful Life = 3 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $261,000 / 3
Annual Depreciation = $87,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$70,000 * (1 - 0.21) + 0.21 * $87,000
Annual OCF = -$37,030

Salvage Value = $47,000

After-tax Salvage Value = $47,000 * (1 - 0.21)
After-tax Salvage Value = $37,130

NPV = -$261,000 - $37,030 * PVIFA(11%, 3) + $37,130 * PVIF(11%, 3)
NPV = -$261,000 - $37,030 * 2.44371 + $37,130 * 0.73119
NPV = -$324,341.4966

EAC = NPV / PVIFA(11%, 3)
EAC = -$324,341.4966 / 2.44371
EAC = -$132,725.04

Techron II:

Cost of Machine = $455,000
Useful Life = 5 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $455,000 / 5
Annual Depreciation = $91,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$43,000 * (1 - 0.21) + 0.21 * $91,000
Annual OCF = -$14,860

Salvage Value = $47,000

After-tax Salvage Value = $47,000 * (1 - 0.21)
After-tax Salvage Value = $37,130

NPV = -$455,000 - $14,860 * PVIFA(11%, 5) + $37,130 * PVIF(11%, 5)
NPV = -$455,000 - $14,860 * 3.69590 + $37,130 * 0.59345
NPV = -$487,886.2755

EAC = NPV / PVIFA(11%, 5)
EAC = -$487,886.2755 / 3.69590
EAC = -$132,007.43