To calculate the Equivalent Annual Cost (EAC), we need to determine the annual cash flows for the project and then discount them back to their present value.
The annual cash flows consist of the OCF (Operating Cash Flow) and the changes in NWC (Net Working Capital).
The OCF is given as $34,000 per year.
The change in NWC is the initial NWC investment minus the NWC recovery at the end of the project. Since there is no salvage value for the fixed asset, the NWC recovery is $0. Therefore, the change in NWC is -$35,000.
The annual cash flow for each year can be calculated as:
Annual Cash Flow = OCF + Change in NWC
Annual Cash Flow = $34,000 + (-$35,000)
Annual Cash Flow = -$1,000
To calculate the Equivalent Annual Cost (EAC), we need to discount the annual cash flows back to their present value using the required return of 10%.
The present value factor for a perpetuity (infinite cash flows) can be calculated as:
Present Value Factor = 1 / (Required Return - Growth Rate)
- Since there is no growth rate in this problem, the present value factor is equal to 1 / Required Return.
Present Value Factor = 1 / 10% = 1 / 0.1 = 10
Finally, the Equivalent Annual Cost (EAC) can be calculated as:
EAC = Annual Cash Flow * Present Value Factor
EAC = -$1,000 * 10
EAC = -$10,000
Therefore, this project's equivalent annual cost (EAC) is -$10,000.
A five-year project has an initial fixed asset investment of $335,000, an initial NWC investment of $35,000, and an annual OCF of ?$34,000. The fixed asset is fully depreciated over the life of the project and has no salvage value. If the required return is 10 percent, what is this project’s equivalent annual cost, or EAC?(Negative 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.)
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