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This extended example illustrates what happens to the EAC when we consider taxes. You are evaluating two different pollution control options. A filtration system will

This extended example illustrates what happens to the EAC when we consider taxes. You are evaluating two different pollution control options. A filtration system will cost $11 million to install and $60,000 annually, before taxes, to operate. It will have to be completely replaced every five years. A precipitation system will cost $1.8 million to install but only $12,000 per year to operate. The precipitation equipment has an effective operating life of eight years. Straight-line depreciation is used throughout, and neither system has any salvage value. Which option should we select if we use a 12 percent discount rate? The tax rate is 21 percent.

Filtration System

Precipitation System

Aftertax operating cost

Depreciation tax shield

Operating cash flow

Economic life

Annuity factor (12% )

Present value of operating cash flow

Capital spending

Total PV of costs


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