Question

SGS Golf Academy is evaluating different golf practice equipment. The "Dimple-Max" equipment costs $162,000, has a 5-year life, and costs $10,000 per year to operate. The relevant discount rate is 12 percent. Assume that the straight-line depreciation method is used and that the equipment is fully depreciated to zero. Furthermore, assume the equipment has a salvage value of $25,000 at the end of the project’s life. The relevant tax rate is 24 percent. All cash flows occur at the end of the year. What is the EAC of this equipment?

Answer 1

EAC : Equivalent Annual Cost ; O & M : Operation and Maintenence ; A : Initial Cost ;  S : Salvage Value

i : Interest ;  T : Tax ; n : Life

Given

A : $162000 ; O&M : $10000 ; S : $25000 ; T : 24% ; n : 5 Yrs ; i : 12%

EAC is the cost per year of owning and operatig an asset over entire lie span

EAC : EAC of capital costs + EAC (O&M)

EAC of Capital costs : (A-S) (i/1-(1+i)^-n) + S * i

S : $25000 * (1-Tax) = 25000*(1-0.24) = 25000 * 0.76 = 19000 (here after tax salvage vaue should be considered because after tax cash flow is the real cash flow)

EAC of Capital Costs : (162000-19000) * (0.12/(1-(1.12)^-5) + 19000 * 0.12 = 143000 * 0.2774 + 2250 = 41948.2

EAC (O&M) : $10000

EAC of The "Dimple-Max" equipment is : EAC of capital costs + EAC (O&M) = 41948.2+10000 = $51948.2