Question

Assume that you have been invited by Letang Industrial Systems Company (LISC) to advise them in deciding between two different conveyor belt systems. System A costs $265,000, has a four-year life, and requires $73,000 in pretax annual operating costs. System B costs $345,000, has a six-year life, and requires $67,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. If the tax rate is 21 percent and the discount rate is 8 percent, which project should the firm choose?

Answer 1

Calculation of EAC of System A
Particulars	0	1	2	3	4
Initial Investment
Cost of system (A)	-265000
Operating Cash Flows
Operating costs (B)		-73000	-73000	-73000	-73000
Depreciation (C ) ($265,000 / 4 years)		-66250	-66250	-66250	-66250
Total Expenses (D = B+C)		-139250	-139250	-139250	-139250
Tax @21% (E = D*21%)		-29242.5	-29242.5	-29242.5	-29242.5
Expenses after tax (F = D-E)		-110007.5	-110007.5	-110007.5	-110007.5
Add back Depreciation (G = -C)		66250	66250	66250	66250
Net Operating Cash Flows (H = F+G)		-43757.5	-43757.5	-43757.5	-43757.5
Total Cash Flows (I = G+H)	-265000	-43757.5	-43757.5	-43757.5	-43757.5
Discount factor @8% (J) 1/(1+8%)^n n=0,1,2,3,4	1	0.925925926	0.85733882	0.793832241	0.735029853
Discounted Cash Flows (K = I*J)	-265000	-40516.2037	-37515.00343	-34736.11429	-32163.06878
Present value	-409930.3902
r = discount rate = 8%
n = 4 years
EAC of the System A = [r*PV] / [1 - (1+r)^-n]
= [8%*-$409,930.3902] / [1 - (1+8%)^-4]
= -$32,794.43122 / 0.264970147
= -$123,766.5132
Calculation of EAC of System B
Particulars	0	1	2	3	4	5	6
Initial Investment
Cost of system (A)	-345000
Operating Cash Flows
Operating costs (B)		-67000	-67000	-67000	-67000	-67000	-67000
Depreciation (C ) ($345,000 / 6 years)		-57500	-57500	-57500	-57500	-57500	-57500
Total Expenses (D = B+C)		-124500	-124500	-124500	-124500	-124500	-124500
Tax @21% (E = D*21%)		-26145	-26145	-26145	-26145	-26145	-26145
Expenses after tax (F = D-E)		-98355	-98355	-98355	-98355	-98355	-98355
Add back Depreciation (G = -C)		57500	57500	57500	57500	57500	57500
Net Operating Cash Flows (H = F+G)		-40855	-40855	-40855	-40855	-40855	-40855
Total Cash Flows (I = G+H)	-345000	-40855	-40855	-40855	-40855	-40855	-40855
Discount factor @8% (J) 1/(1+8%)^n n=0,1,2,3,4	jeff jeffy Next > < Previous Related Solutions Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System... Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $335,000, has a four-year life, and requires $129,000 in pretax annual operating costs. System B costs $415,000, has a six-year life, and requires $123,000 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 9 percent. Calculate the... Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System... Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. 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