Question

A project with a life of 7 has an initial fixed asset investment of $27,720, an initial NWC investment of $2,640, and an annual OCF of –$42,240. The fixed asset is fully depreciated over the life of the project and has no salvage value.

  

If the required return is 16 percent, what is the project's equivalent annual cost, or EAC?

Answer 1

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-27720
Initial working capital		-2640
=Initial Investment outlay		-30360
Sales			0	0	0	0	0	0	0
Profits	Sales-variable cost		0	0	0	0	0	0	0
-Depreciation	Cost of equipment/no. of years		-3960	-3960	-3960	-3960	-3960	-3960	-3960
=Pretax cash flows			-3960	-3960	-3960	-3960	-3960	-3960	-3960
-taxes	=(Pretax cash flows)*(1-tax)		-3960	-3960	-3960	-3960	-3960	-3960	-3960
+Depreciation			3960	3960	3960	3960	3960	3960	3960
=after tax operating cash flow			-42240	-42240	-42240	-42240	-42240	-42240	-42240
reversal of working capital									2640
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									2640
Total Cash flow for the period		-30360	-42240	-42240	-42240	-42240	-42240	-42240	-39600
Discount factor=	(1+discount rate)^corresponding period	1	1.16	1.3456	1.560896	1.8106394	2.1003417	2.4363963	2.82622
Discounted CF=	Cashflow/discount factor	-30360	-36413.8	-31391.2	-27061.38	-23328.78	-20111.01	-17337.08	-14011.6
NPV=	Sum of discounted CF=	-200014.8942
EAC	-49526.22341
Year or period		0	1	2	3	4	5	6	7
EAC			-49526.2	-49526.2	-49526.22	-49526.22	-49526.22	-49526.22	-49526.2
Discount factor=	(1+discount rate)^corresponding period		1.16	1.3456	1.560896	1.8106394	2.1003417	2.4363963	2.82622
Discounted CF=	Cashflow/discount factor		-42695	-36806.1	-31729.36	-27352.89	-23580.08	-20327.65	-17523.8
NPV=	-200014.8942
EAC is equivalent yearly CF with same NPV =	-49526.22341