Problem 3 You are a recycler of spent plutonium rods from nuclear reactors, and

Question

Problem 3

You are a recycler of spent plutonium rods from nuclear reactors, and a new government mandate requires you to purchase a filtration system for your wastewater. You can choose between two machines.  

Machine 1 has a four-year life and costs 300,000. It has an annual pre-tax operating cost of $25,000 in the first year. The operating costs are expected to increase at the rate of 5% per year for the life of machine.

Machine 2 has a six-year life costs $180,000. It has an annual pre-tax operating cost of $20,000 in the first year. The operating costs for the second machine are expected to increase at the rate of 8% per year for the life of the machine.

You do not foresee any further changes in environmental laws or changes in water filtration technology.  Both machines have zero salvage values. Both machines belong to CCA class 22 with a depreciation rate of 50% and the corporate tax rate is 34% and the appropriate discount rate is 12%.

a. What is the NPV from investing in Machine 1?  

b. What is the NPV from investing in Machine 2?

c. What is machine 1's EAC?

d. What is machine 2's EAC?

e. Which machine would you buy?

Explanation / Answer

a. NPV= 300000 + [(25000(1-0.34)/1.12)+150000] + [(25000+(1-0.34)*(1.05)/(1.12)^2)+75000] + [25000(1-0.34)*(1.05)^2/(1.12)^3+37500] + (25000(1-0.34)*(1.05)^3/(1.12)^4+18750)
= 506980
Depreciation=300000*50%=150000
2nd yr=150000*50%=75000
3rd yr=75000*50%=37500
4 yr=37500*50%=18750
b) NPV=180000+(20000(1-0.34)/1.12+90000) + (20000(1-0.34)*(1.08)/(1.12)^2+45000) + (20000(1-0.34)*(1.08)^2/(1.12)^3+22500) + [(20000(1-0.34)*(1.08)^3/(1.12)^4)+11250]+ [20000(1-0.34)*(1.08)^4/(1.12)^5)+5625]+ [20000(1-0.34)*(1.08)^5/(1.12)^6)+2813]
= 339741.26

c. EAC=506980/3.037=506980

d. EAC=339741.26/4.111=82642

e. We would buy machibe 2 as its EAC is less than machine 1.

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