You are evaluating two different tractors. The Tractor I costs $202,000, has a 3

Question

You are evaluating two different tractors. The Tractor I costs $202,000, has a 3-year life, and has pretax operating costs of $38,000 per year. The Tractor II costs $307,000, has a 5-year life, and has pretax operating costs of $19,000 per year. For both farm 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 33 percent and your discount rate is 13 percent. The Tractor I has an EAC of ? , and the Techron II has an EAC of?

Explanation / Answer

We will need the after tax salvage value of the equipment to compute the EAC. Even though the equipment for each product has a different initial cost, both have the same salvage value. The after tax salvage value for both is: Both cases: aftertax salvage value = $20,000 (1-0.33) = $13,400 To calculate the EAC, we first need the OCF and NPV of each option. The OCF and NPV for Techron I is: OCF = - $38,000(1-0.33) + 0.33($202,000/3) = -3,240$ NPV = -$202,000 - $3,240(PVIFA 13%,3) +($13,400/(1.13^3)) = -$200,363.42 EAC = -$200,363.42 / (PVIFA 13%,3) = -$84,856.60 And the OCF and NPV for Techron II is: OCF = -$19,000 (1

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