Question

A restaurant is considering buying a new coffee making machine, which will be replaced over and over with a new one when an old one dies. Each coffee making machine costs $113,000, and is expected to die after exactly 5-years. Each machine will costs $9,200 per year to operate. The discount rate that the restaurant assigns to this coffee making machine project is 9 percent per year. The straight-line depreciation method would be used when calculating the machine's loss of value for tax purposes. Each coffee making machine will be fully depreciated all the way to zero at the end of its life. Also, each coffee making machine will have a before-tax salvage value of $8,500 at the end of its life. The restaurant's tax rate is 25 percent. As always, assume that all cash flows occur at year end. If the restaurant buys a coffee making machine over and over in perpetuity, as soon as one dies, what would be the average, or the equivalent, annual cost (EAC) of the machine? (Since cost is a cash outflow, a negative dollar amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)What is the EAC?

Answer 1

Restaurant's Coffee-Making Machine

The Equivalent annual cost (EAC) of the machine is:

= $37,184

Step-by-step explanation:

a) Data and Calculations:

Cost of each coffee making machine = $113,000

Estimated useful life = 5 years

Estimated annual operating cost = $9,200

Assigned discount rate = 9%

Before-tax salvage value = $8,500

Restaurant's tax rate = 25%

After-tax salvage value = $6,375 ($8,500 * (1 - 0.25)

Annuity factor for 5 years at 9% = 3.890

Discount factor for 5 years at 9% = 0.650

Present values:

Initial cost ($113,000 * 1) = $113,000

Annual operating cost ($9,200 * 3.890) 35,788

Salvage value ($6,375 * 0.650) = (4,144)

Total cost = $144,644

Equivalent annual cost of the machine = $37,184 ($144,644/3.890)