Question

Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $330,000, has a 4-year life, and requires $125,000 in pretax annual operating costs. System B costs $410,000, has a 6-year life, and requires $119,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Suppose the company always needs a conveyor belt system; when one wears out, it must be replaced. Assume the tax rate is 23 percent and the discount rate is 8 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

System A:

Cost of Machine = $330,000
Useful Life = 4 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $330,000 / 4
Annual Depreciation = $82,500

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$125,000 * (1 - 0.23) + 0.23 * $82,500
Annual OCF = -$77,275

NPV = -$330,000 - $77,275 * PVIFA(8%, 4)
NPV = -$330,000 - $77,275 * (1 - (1/1.08)^4) / 0.08
NPV = -$330,000 - $77,275 * 3.3121268
NPV = -$585,944.60

EAC = NPV / PVIFA(8%, 4)
EAC = -$585,944.60 / 3.3121268
EAC = -$176,908.87

System B:

Cost of Machine = $410,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $410,000 / 6
Annual Depreciation = $68,333.333

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$119,000 * (1 - 0.23) + 0.23 * $68,333.333
Annual OCF = -$75,913.333

NPV = -$410,000 - $75,913.333 * PVIFA(8%, 6)
NPV = -$410,000 - $75,913.333 * (1 - (1/1.08)^6) / 0.08
NPV = -$410,000 - $75,913.333 * 4.6228797
NPV = -$760,938.206

EAC = NPV / PVIFA(8%, 6)
EAC = -$760,938.206 / 4.6228797
EAC = -$164,602.64