You are evaluating two different silicon wafer milling machines. The Techron I c

Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $261,000, has a three-year life, and has pretax operating costs of $70,000 per year. The Techron II costs $455,000, has a five-year life, and has pretax operating costs of $43,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $47,000. If your tax rate is 25 percent and your discount rate is 9 percent, compute the EAC for both machines.

You are evaluating two different silicon wafer milling machines. The Techron I costs $261,000, has a three-year life, and has pretax operating costs of $70,000 per year. The Techron II costs $455,000, has a five-year life, and has pretax operating costs of $43,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $47,000. If your tax rate is 25 percent and your discount rate is 9 percent, compute the EAC for both machines.

Explanation / Answer

Aftertax salvage value for both machines = $47,000(1 – 0.25) = $35,250

To calculate the EAC, we first need the OCF and NPV of each option.

The OCF and NPV for Techron I is:

OCF = – $70,000(1 – 0.25) + 0.25($261,000/3) = - $30,750

NPV = –$261,000 - $30,750(PVIFA 9%,3) + ($35,250/1.093) = –$311,618.01

EAC = –$311,618.01 / (PVIFA 9%,3)= –$123,105.92

The OCF and NPV for Techron II is:

OCF = – $43,000(1 – 0.25) + 0.25($455,000/5) = - $9,500

NPV = –$455,000 - $9,500(PVIFA 9%,5) + ($35,250/1.095) = –$469,042.07

EAC = –$469,042.07 / (PVIFA 9%,5)= –$120,585.67

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