Question

Bridgton Golf Academy is evaluating new golf practice equipment. The "Dimple-Max" equipment costs $110,000, has a 4-year life, and costs $9,100 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 $8,300 at the end of the project’s life. The relevant tax rate is 24 percent. All cash flows occur at the end of the year. What is the equivalent annual cost (EAC) of this equipment?

Answer 1

The After-tax salvage Value

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

= $8,300 x (1 – 0.24)

= $8,300 x 0.76

= $6,308

Operating Cash Flow (OCF)

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

= [−$9,100 x (1 – 0.24)] + [($110,000 / 4 Years) x 0.24]

= [-$9,100 x 0.76] + [$27,500 x 0.24]

= -$6,916 + $6,600

= -$316

Net Present Value

Period	Annual Cash Flow ($)	Present Value factor at 10%	Present Value of Cash Flow ($)
1	-316	0.892857	-282.14
2	-316	0.797194	-251.91
3	-316	0.711780	-224.92
4	5,992 [-316 + 6,308]	0.635518	3,808.02
TOTAL		3.037349	3,049.05

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

= -$3,049.05 - $110,000

= -$106,950.95

Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) = Net Present Value / [PVIFA 12%, 4 Years]

= -$106,950.95 / 3.037349

= -$35,211.94 (Negative)

“Hence, the Equivalent Annual Cost (EAC) of this equipment will be -$35,211.94 (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.