Your ﬁrm needs a computerized line-boring machine which costs $80,000, and requires $20,000 in maintenance for each year of its three year life. After three years, the salvage value will be zero.
The machine falls into the Class 10 equipment category (CCA rate 30%). Assume a tax rate of 34%
And a discount rate of 10%.
What is the project's EAC?

Question

Quizplus · Accepted Answer

1. Calculate the depreciation using the CCA rate of 30%:
Year 1: $80,000 x 30% = $24,000
Year 2: ($80,000 – $24,000) x 30% = $16,800
Year 3: ($80,000 – $24,000 – $16,800) x 30% = $9,240
Total depreciation = $24,000 + $16,800 + $9,240 = $50,040

2. Calculate the after-tax cash flow for each year:
Year 0: -$80,000 (initial investment)
Year 1: -$20,000 (maintenance) - $14,676 (tax shield) + $24,000 (depreciation) = -$10,676
Year 2: -$20,000 (maintenance) - $8,670 (tax shield) + $16,800 (depreciation) = -$11,870
Year 3: -$20,000 (maintenance) - $3,146 (tax shield) + $9,240 (depreciation) = -$13,906

3. Calculate the present value of each cash flow:
Year 0: -$80,000 / (1 + 0.10)^0 = -$80,000
Year 1: -$10,676 / (1 + 0.10)^1 = -$9,705
Year 2: -$11,870 / (1 + 0.10)^2 = -$9,321
Year 3: -$13,906 / (1 + 0.10)^3 = -$9,590
Total present value = -$108,616

4. Calculate the EAC using the formula:
EAC = (A/P, 10%, 3) x -$108,616
A/P, 10%, 3 = 0.4024 (from the table)
EAC = 0.4024 x -$108,616 = -$43,714
However, we need to add back the annual tax shield:
EAC = -$43,714 - $8,825 = -$37,539

Therefore, the best choice is C, with an EAC of -$37,539.

Your ﬁRm Needs a Computerized Line-Boring Machine Which Costs $80,000