Question

Bullworks Systems is trying to decide between two conveyor belt systems. System A costs $450,000, has a three year life and requires $15000 in pretax annual operating costs. System B costs $500,000, has a five year life and requires $80,000 in pretax annual operating costs. Both systems are to be depreciated straight line to zero over their lives and will have zero salvage value. If the pretax rate is 34 percent and the discount rate is 20% which project should Bullworks choose?

Answer 1

Select System A since it has a lower Equivalent annual cost.

	System A					System B
Year	Initial cost	Operating cost	Tax shield	Net CF		Initial cost	Operating cost	Tax shield	Net CF
0	-450000			-450000		-500000			-500000
1		-9900	51000	41100			-52800	34000	-18800
2		-9900	51000	41100			-52800	34000	-18800
3		-9900	51000	41100			-52800	34000	-18800
4							-52800	34000	-18800
5							-52800	34000	-18800
			NPV	-363423.61				NPV	-556223.51
			EUAC	$172,526.37				EUAC	$185,989.85

Workings