1. 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 $3 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 $2 million to install but only $10,000 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.

We need to consider the EACs for the two systems because they have different service lives and will be replaced as they wear out. The relevant information can be summarized as follows:

	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