1. You are evaluating two different silicon wafer milling machines. The Techron
ID: 2645802 • Letter: 1
Question
1. You are evaluating two different silicon wafer milling machines. The Techron I costs $246,000, has a three-year life, and has pretax operating costs of $65,000 per year. The Techron II costs $430,000, has a five-year life, and has pretax operating costs of $38,000 per year. For both milling machines, use straight-line depreciation to zero over the project
1. You are evaluating two different silicon wafer milling machines. The Techron I costs $246,000, has a three-year life, and has pretax operating costs of $65,000 per year. The Techron II costs $430,000, has a five-year life, and has pretax operating costs of $38,000 per year. For both milling machines, use straight-line depreciation to zero over the project
Explanation / Answer
Part 1)
NPV is the difference between the present value of cash outflows and present value of cash inflows. The general formula for calculating NPV is:
NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3
Annual Cash Flow = (Sales - Costs - Depreciation)*(1-Tax Rate) + Depreciation
Depreciation = Initial Cost/Estimated Life
_________________
Using the information provided in the question, we get,
Annual Depreciation = 2,430,000/3 = $810,000
Annual Cash Flow = (1,990,000 - 685,000 - 810,000)*(1-30%) + 810,000 = $1,156,500
_________________
Using the above calculated values in the NPV formula, we get,
NPV = -2,430,000 + 1,156,500/(1+18%)^1 + 1,156,500/(1+18%)^2 + 1,156,500/(1+18%)^3 = $84,546.64
_________________________________
Part 2)
We need to calculate the annual cash flows for each type of machine. The formula for calculating cash flow would be;
Cash Flow = -Annual Operating Cost*(1-Tax Rate) + Depreciation*(Tax Rate)
Depreciation = Estimated Cost/Life
The cash flow in final year would also include the amount of after tax salvage value, the formula for which is:
After Tax Salvage Value = Salvage Value*(1-Tax Rate)
________________
With the use of these Cash Flows, we will have to calculate the NPV for each type of machine.
The general formula for calculating NPV is:
NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Discount Rate)^1 + Cash Flow Year 2/(1+Discount Rate)^2 + Cash Flow Year 3/(1+Discount Rate)^3 and so on.
________________
With the use of NPV, we will have to the calculate the EAC. The formula for calculating EAC is:
EAC = NPV/PVIFA(r,n) where r is discount rate, n is years and PVIFA is Present Value Interest Factor for An Annuity
_________________
Step 1: Calculate Annual Cash Flows for Each Type of Machine
Cash Flow (Techron 1) = -65,000*(1-34%) + 246,000/3*(34%) = -$15,020
After Tax Salvage Value (Techron 1) = 42000*(1-34%) = $27,720 (only in Third Year)
Cash Flow (Techron 2) = -38000*(1-34%) + 430000/5*(34%) = $4,160
After Tax Salvage Value (Techron 2) = 42000*(1-34%) = $27,720 (only in Fifth Year)
_________________
Step 2: Calculate NPV for Each Type of Machine
NPV (Techron 1) = -246,000 - 15,020/(1+8%)^1 - 15,020/(1+8%)^2 + (-15,020 + 27,720)/(1+8%)^3 = -$262702.97
NPV (Techron 2) = - 430,000 + 4160/(1+8%)^1 + 4160/(1+8%)^2 + 4160/(1+8%)^3 + 4160/(1+8%)^4 + (4160 +27720)/(1+8%)^5 = -$394,524.56
_________________
Step 3: Calculate EAC for Each Type of Machine
EAC (Techron 1) = -262,702.97/PVIFA(8%,3Years) = -262,702.97/2.5771 = -$101,937.44 (there can be a slight difference resulting from rounding off)
EAC (Techron 2) = -394,524.56/PVIFA(8%,5Years) = -394,524.56/3.9927 = -$98,811.47 there can be a slight difference resulting from rounding off)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.