Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $256,000, has a four-year life, and requires $79,000 in pretax annual operating costs. System B costs $360,000, has a six-year life, and requires $73,000 in pretax annual operating costs. Suppose LISC always needs a conveyor belt system; when one wears out, it must be replaced. Assume the tax rate is 35 percent and the discount rate is 10 percent.

System A?

System B?

Which conveyor belt system should the firm choose?

Answer 1

post tax operating cost

system A = post tax operating cost*(1-tax rate) = 79000*(1-0.35)=51530

system B = post tax operating cost*(1-tax rate) = 73000*(1-0.35)=47450

System A
Discount rate	10.000%
Year	0	1	2	3	4
Cash flow stream	-256000.000	-51530.000	-51530.000	-51530.000	-51530.000
Discounting factor	1.000	1.100	1.210	1.331	1.464
Discounted cash flows project	-256000.000	-46845.455	-42586.777	-38715.252	-35195.683
NPV = Sum of discounted cash flows
NPV System A =	-419343.17
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Equvalent annuity(EAA)=	-100565.16
Required rate =	10.000%
Year	0	1	2	3	4
Cash flow stream	-100565.16	-100565.16	-100565.16	-100565.16	-100565.16
Discounting factor	1.000	1.100	1.210	1.331	1.464
Discounted cash flows project	-100565.156	-91422.869	-83111.699	-75556.090	-68687.355
Sum of discounted future cashflows =	-419343.17
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

System B
Discount rate	10.000%
Year	0	1	2	3	4	5	6
Cash flow stream	-360000.000	-47450.000	-47450.000	-47450.000	-47450.000	-47450.000	-47450.000
Discounting factor	1.000	1.100	1.210	1.331	1.464	1.611	1.772
Discounted cash flows project	-360000.000	-43136.364	-39214.876	-35649.887	-32408.988	-29462.717	-26784.288
NPV = Sum of discounted cash flows
NPV System B =	-566657.12
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Equvalent annuity(EAA)=	-105813.17
Required rate =	10.000%
Year	0	1	2	3	4	5	6
Cash flow stream	-105813.17	-105813.17	-105813.17	-105813.17	-105813.17	-105813.17	-105813.17
Discounting factor	1.000	1.100	1.210	1.331	1.464	1.611	1.772
Discounted cash flows project	-105813.172	-96193.792	-87448.902	-79499.002	-72271.820	-65701.655	-59728.777
Sum of discounted future cashflows =	-566657.12
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Choose system A as it has smaller equivalent annuity