Calculating EAC You are evaluating two different silicon wafer milling machines. The Techron I costs $245,000, has a three-year life, and has pretax operating costs of $39,000 per year. The Techron 11 costs $315,000, has a five-year life, and has pretax operating costs of $48,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $20,000. If your tax rate is 35 percent and your discount rate is 9 percent, compute the EAC for both machines. Which do you prefer? Why?
To identify: The EAC of both the machines and the machine to be preferred.
Equivalent Annual Cost (EAC):
Equivalent annual cost is the cost incurred to maintain and operate a machine during its life. It can be used in capital budgeting decision and helps in comparing various assets.
Explanation of Solution
Machine T I
Given,
Cost of machine is $245,000.
Operating costs is $39,000.
Estimated life of machine is 3 years.
Market price of machine after 3 years $20,000.
Tax rate is 35%.
Discount rate is 9%.
Calculated values,
Net present value is
Present value interest factor (PVIFA) at 9% for 3 years is 2.531.
Formula to calculate equivalent annual cost,
Substitute
Machine T II
Given,
Cost of machine is $315,000.
Operating costs is $48,000.
Estimated life of machine is 5 years.
Market price of machine after 5 years $20,000.
Tax rate is 35%.
Discount rate is 9%.
Calculated values,
Net present value is
Present value interest factor (PVIFA) at 9% for 5 years is 2.531.
Formula to calculate equivalent annual cost,
Substitute
Working notes:
Machine T I
Calculation of after tax salvage value of asset,
Calculation of operating cash flows,
Calculation of net present value,
Machine T II
Calculation of after tax salvage value of asset,
Calculation of operating cash flows,
Calculation of net present value,
Hence, EAC of machine T I and T II is
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Chapter 6 Solutions
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