Question

1. Bridgton Golf Academy is evaluating different golf practice equipment. The “Dimple-Max” equipment costs $94,000, has a three-year life, and costs $8,600 per year to operate. The relevant discount rate is 12 percent. Assume that the straight-line depreciation method is used and that the equipment is fully depreciated to zero. Furthermore, assume the equipment has a salvage value of $18,000 at the end of the project's life. The relevant tax rate is 34 percent. All cash flows occur at the end of the year. What is the equivalent annual cost (EAC) of this equipment?

Answer 1

Calculation of cash flow from year 0 to 3

Year 0

Initial cost. -94000

Year 1 to 3 (Annual cash flow)

Operating cost. -8600

Tax benefit of Operating cost

(8600*34%)=. 2924

Tax benefit of Depreciation

(Depreciation * tax rate)

(94000/3 * 34%) 10653.33

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Annual cash flows. 4977.33

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Year 3 (after-tax salvage value)

Salvage value 18000

Tax on capital gain (18000*34%) -6120

(full value is deppreciated. so tax

will be payable on capital gain of

18000)

______________________________________

Cash flow from salvage. 11880

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Calculation of NPV

Year Cash flows P.V.F.@ 12%. P.V.

year 0 -94,000.00 1.0000 -94,000.00

Year 1 4,977.33 0.8929 4,444.05

Year 1. 4,977.33 0.7972. 3,967.90

Year 3 4,977.33. 0.7118. 3,542.77

salvage 11,880.00 0.7118 8455.95

Value

__________________________________________________________

N P.V. -73,589.34

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Equivalent Annual Cost formula = r * NPV / {1- (1/1+r)n) }

12% * -73589.34/(1-(1/((1+12%)^3)))

-30638.85

So, EUAC of this equipment is -$30638.85.