A five-year project has an initial fixed asset investment of $295,000, an initial NWC investment...

Question:

A five-year project has an initial fixed asset investment of $295,000, an initial NWC investment of $27,000, and an annual OCF of $26,000. The fixed asset is fully depreciated over the life of the project and has no salvage value. If the required return is 12 percent, what is this project s equivalent annual cost, or EAC?

Fixed Investment Assets:

The fixed investment assets are the assets that exist for a long period. The example of the fixed investment assets is the purchase of plant and machinery, building, equipment and etc, which is primarily used by the company as part of their operation.

Answer and Explanation:

Step 1 of 2:

We need to calculate the net present value of the project using the following formula:

{eq}\begin{align*} NPV&=-(Initial~investment+Initial~NWC)-[OCF*(PVIFA~rate, time)]\\ &=-(295,000+27,000)-[26,000*(PVIFA~12\%, 5)]\\ &=-322,000-(26,000*3.6048)\\ &=-322,000-93,724.18\\ &=-415,724.80\\ \end{align*} {/eq}

The net present value of the project is -$415,724.80


Step 2 of 2:

We can now calculate the equivalent annual cost of the project.

{eq}\begin{align*} EAC&=\dfrac{NPV}{PVIFA rate, time}\\ &=\frac{-415,724.80}{PVIFA~12\%, 5}\\ &=\frac{-415,724.80}{3.6048}\\ &=-115,325.3 \end{align*} {/eq}

The equivalent annual cost of the project is $115,325.30


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