Question

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $290,000, has a four-year life, and requires $93,000 in pretax annual operating costs. System B costs $370,000, has a six-year life, and requires $87,000 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 25 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

Conveyor A:

Cost of Machine = $290,000
Useful Life = 4 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $290,000 / 4
Annual Depreciation = $72,500

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$93,000 * (1 - 0.25) + 0.25 * $72,500
Annual OCF = -$51,625

NPV = -$290,000 - $51,625 * PVIFA(8%, 4)
NPV = -$290,000 - $51,625 * 3.31213
NPV = -$460,988.71125

EAC = NPV / PVIFA(8%, 4)
EAC = -$460,988.71125 / 3.31213
EAC = -$139,181.95

Conveyor B:

Cost of Machine = $370,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $370,000 / 6
Annual Depreciation = $61,666.67

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$87,000 * (1 - 0.25) + 0.25 * $61,666.67
Annual OCF = -$49,833.3325

NPV = -$370,000 - $49,833.3325 * PVIFA(8%, 6)
NPV = -$370,000 - $49,833.3325 * 4.62288
NPV = -$600,373.51615

EAC = NPV / PVIFA(8%, 4)
EAC = -$600,373.51615 / 4.62288
EAC = -$129,870.02