Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $246,000, has a 3-year life, and has pretax operating costs of $65,000 per year. The Techron II costs $430,000, has a 5-year life, and has pretax operating costs of $38,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $42,000. If your tax rate is 21 percent and your discount rate is 10 percent, compute the EAC for both machines.

Techron I

Techron II

Answer 1

As per given information, table as below

Particulars	Techron 1	Techron 2
Cost	246000	430000
Life	3	5
Pretax Operating Costs	65000	38000
Salvage Value	42000	42000
Tax Rate	21%	21%
Discount Rate	10%	10%
Depreciation	82000	86000
Tax shield on Depreciation @ 21% on Dep	17220	18060

In order to calculate the Equivalent Annual Cost of Investment we will calculate PV of both options

1) PV of both options

PV of Techron 1 Cost= Initial Cost of Asset + PV of Operating Costs-PV of Tax Shield on Depreciation - PV of Salvage value at the end of 3rd year.

= (246000)+(65000/(1.1)+65000/(1.1)^2+65000/(1.1)^3)-(17220/(1.1)+17220/(1.1)^2+17220/(1.1)^3)-(42000/(1.1)^3)

= 246000+(59090.91+53719.01+48835.46)-(15654.55+14231.40+12937.64)-(31555.22)

= 246000+161645.38-42823.59-31555.22

=333266.57

PV of Techron 2 Cost= Initial Cost of Asset + PV of Operating Costs-PV of Tax Shield on Depreciation - PV of Salvage value at the end of 3rd year.

= (430000)+(38000/(1.1)+38000/(1.1)^2+38000/(1.1)^3+38000/(1.1)^4+38000/(1.1)^5)-(18060/(1.1)+18060/(1.1)^2+18060/(1.1)^3+18060/(1.1)^4+18060/(1.1)^5)-(42000/(1.1)^5)

= 430000+(34545.45+31404.96+28549.96+25954.51+23595.01)-(16418.18+14925.62+13568.75+12335.22+11213.84)-(26078.70)

= 430000+144049.89-68461.61-26078.70

=479509.58

EAC is calculated as below

EAC Techron 1 = NPV of Project x r/(1-(1+r)^-n)

=333266.57 *10%/(1-(1.1)^-3)

=333266.57*0.402115

= 134011.42

EAC Techron 2 = NPV of Project x r/(1-(1+r)^-n)

=479509.58 *0.263797

= 126493.42

Based on EAC, Techron 2 should be selected.