Question

ou are evaluating two different silicon wafer milling machines. The Techron I costs $219,000, has a three-year life, and has pretax operating costs of $56,000 per year. The Techron II costs $385,000, has a five-year life, and has pretax operating costs of $29,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $33,000. If your tax rate is 34 percent and your discount rate is 8 percent, compute the EAC for both machines. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

EAC Techron I $ ??

EAC Techron II ??

Answer 1

The After-tax salvage Value

After-tax salvage value = Salvage Value x (1 – Tax Rate)

= $33,000 x (1 – 0.34)

= $21,780

Equivalent Annual Cost (EAC) for Techron I

Operating Cash Flow (OCF)

Operating Cash Flow (OCF) = Pretax Cost Savings(1 – Tax Rate) + (Depreciation x Tax Rate)

= [−$56,000(1 − 0.34)] + [($219,000 / 3 Years) x 0.34]

= −$36,960 + $24,820

= -$12,140

Net Present Value

Period	Annual Cash Flow ($)	Present Value factor at 8%	Present Value of Cash Flow ($)
1	-12,140	0.925926	-11,240.74
2	-12,140	0.857339	-10,408.09
3	9,640 [-$12,140 + $21,780]	0.793832	7,652.54
TOTAL		2.577097	-13,996.29

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

= -$13,996.29 - $219,000

= -$232,996.29

Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) = Net Present Value / [PVIFA 8%, 3 Years]

= -$232,996.29 / 2.577097

= -$90,410.37 (Negative)

Equivalent Annual Cost (EAC) for Techron II

Operating Cash Flow (OCF)

Operating Cash Flow (OCF) = Pretax Cost Savings(1 – Tax Rate) + (Depreciation x Tax Rate)

= [−$29,000(1 − 0.34)] + [($385,000 / 5 Years) x 0.34]

= −$19,140 + $26,180

= $7,040

Net Present Value

Period	Annual Cash Flow ($)	Present Value factor at 8%	Present Value of Cash Flow ($)
1	7,040	0.925926	6,518.52
2	7,040	0.857339	6,035.67
3	7,040	0.793832	5,588.58
4	7,040	0.735030	5,174.61
5	28,820 [$7,040 + $21,780]	0.680583	19,614.41
TOTAL		3.992710	42,931.78

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

= $42,931.78 - $385,000

= -$342,068.22

Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) = Net Present Value / [PVIFA 8%, 5 Years]

= -$342,068.22 / 3.992710

= -$85,673.19 (Negative)

DECISION

We should prefer the “Techron I” since it has the lower Equivalent Annual Cost (EAC) of -$85,673.19 as compared with the Equivalent Annual Cost (EAC) of Techron II.

Equivalent Annual Cost (EAC) for Techron I = -$90,410.37 (Negative)

Equivalent Annual Cost (EAC) for Techron II = -$85,673.19 (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.