Question

Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $285,000, has a 4-year life, and requires $89,000 in pretax annual operating costs. System B costs $365,000, has a 6-year life, and requires $83,000 in pretax annual operating costs. Suppose the company always needs a conveyor belt system; when one wears out, it must be replaced. Assume the tax rate is 24 percent and the discount rate is 11 percent. Calculate the EAC for both conveyor belt systems. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $.

Parameter	Linkage	System A	System B
Initial cost	A	(285,000.00)	(365,000.00)
Life	B	4.00	6.00
Annual depreciation	C = - A/ B	71,250.00	60,833.33
Pre tax operating cost	D	(89,000.00)	(83,000.00)
Tax rate	E	24%	24%
Post tax operating cost	F = D x (1 - E)	(67,640.00)	(63,080.00)
Depreciation tax shield	G = C x E	17,100.00	14,600.00
Annual cash flows	H = F + G	(50,540.00)	(48,480.00)
Discount rate	I	11%	11%
Annual equivalent of initial cost	J = PMT(I,B,-A)	(91,863.01)	(86,277.45)
EAC	H + J	(142,403.01)	(134,757.45)