You are evaluating two different silicon wafer milling machines. the techron i costs $290,000, has a three-year life, and has pretax operating costs of $67,000 per year. the techron ii costs $510,000, has a five-year life, and has pretax operating costs of $35,000 per year. for both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $40,000. if your tax rate is 35 percent and your discount rate is 10 percent, compute the equivalent annual cost for both machines. which do you prefer? why?

EAC techron I =   130,996.7425

EAC techron II = 124,386.7141

I would prefer techron II as their annual cost is lower than techron I

Explanation:

The first step is calculate the NPV of each machine

Techron I

investment 290,000

Depreciation per year

acquisition - salvage value = depreciable amount

depreciable amount / useful life = depreciation per year

290,000 - 40,000 = 250,000

250,000/3 = 83,333

The depreication provides a tax-shield so it lowers the annual cost for the machine.

operating cost x (1-t) - depreciation x t = after-tax operating cost

-67,000 x (1-0.35) +83,333 x 0.35 = 14383.45

Now we calculate the present value of there cash outflow for 3 years

C-14383.45

time3

rate0.1

PV-$35,769.51

Now the NPV of the machine Techron I

-290,000  -  35,769.51 = -325.769,51‬

We do the same for the second machine Techron II

after-tax cost:

depreciation per year:

(510,000-40,000)/5

-35,000 x (1-.035) +  94,000 x 0.35 = 10.150

The tax shield for the depreciation is high enough it makes cost savings rather than cost outflow.

Now we calculate the present value of this aannuity

C10150

time5

rate0.1

PV$38,476.49

And the NPV for Techron II

-510,000 + 38,476.49 = (471,523.51‬)

Now we are able to calcualte the EAC for each machine:

First Machine Techron I

EAC techron I = 130996.7425

Second Machine Techron II

EAC techron II = 124386.7141

d. low interest rates