Question

A project with a life of 7 has an initial fixed asset investment of $27,720, an initial NWC investment of $2,640, and an annual OCF of –$42,240. The fixed asset is fully depreciated over the life of the project and has no salvage value.

  

If the required return is 16 percent, what is the project's equivalent annual cost, or EAC?

Answer 1

Project's Equivalent Annual Cost, or EAC

Net Present Value of the Project

Year	Annual Cash Flow ($)	Present Value factor at 16%	Present Value of Annual Cash Flow ($)
1	-42,240	0.862069	-36,413.79
2	-42,240	0.743163	-31,391.20
3	-42,240	0.640658	-27,061.38
4	-42,240	0.552291	-23,328.78
5	-42,240	0.476113	-20,111.01
6	-42,240	0.410442	-17,337.08
7	-39,600 [-$42,240 + $2,640]	0.353830	-14,011.65
TOTAL		4.038565	-1,69,654.89

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

= -$1,69,654.89 – [$27,720 + $2,640]

= -$1,69,654.89 – $30,360

= -$2,00,014.89 (Negative)

Project's Equivalent Annual Cost, or EAC

Project's Equivalent Annual Cost, or EAC = Net Present Value / [PVIFA 16%, 7 Years]

= -$2,00,014.89 / 4.038565

= -$49,526.22 (Negative)

“Hence, the Project's Equivalent Annual Cost, or EAC would be -$49,526.22 (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.