Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $236,000, has a four-year life, and requires $74,000 in pretax annual operating costs. System B costs $336,000, has a six-year life, and requires $68,000 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 30 percent and the discount rate is 9 percent.

Calculate the EAC for both conveyor belt systems. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	EAC
System A	$
System B	$

Which conveyor belt system should the firm choose?

System B System A

Answer 1

After tax cash flow = pre tax cash flow*(1-tax rate) =- 74000*(1-0.3)=-51800

System A
Discount rate	9.000%
Year	0	1	2	3	4
Cash flow stream	-236000.000	-51800.000	-51800.000	-51800.000	-51800.000
Discounting factor	1.000	1.090	1.188	1.295	1.412
Discounted cash flows project	-236000.000	-47522.936	-43599.024	-39999.104	-36696.426
NPV = Sum of discounted cash flows
NPV System A =	-403817.49
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Equvalent annuity(EAA)=	-124645.80
Required rate =	9.000%
Year	0	1	2	3	4
Cash flow stream	0.00	-124645.80	-124645.80	-124645.80	-124645.80
Discounting factor	1.000	1.090	1.188	1.295	1.412
Discounted cash flows project	0.000	-114353.949	-104911.880	-96249.431	-88302.230
Sum of discounted future cashflows =	-403817.49
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

After tax cash flow = pre tax cash flow*(1-tax rate) =- 68000*(1-0.3)=-47600

System B
Discount rate	9.000%
Year	0	1	2	3	4	5	6
Cash flow stream	-336000.000	-47600.000	-47600.000	-47600.000	-47600.000	-47600.000	-47600.000
Discounting factor	1.000	1.090	1.188	1.295	1.412	1.539	1.677
Discounted cash flows project	-336000.000	-43669.725	-40063.968	-36755.934	-33721.040	-30936.734	-28382.325
NPV = Sum of discounted cash flows
NPV System B =	-549529.72
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Equvalent annuity(EAA)=	-122501.05
Required rate =	9.000%
Year	0	1	2	3	4	5	6
Cash flow stream	0.00	-122501.05	-122501.05	-122501.05	-122501.05	-122501.05	-122501.05
Discounting factor	1.000	1.090	1.188	1.295	1.412	1.539	1.677
Discounted cash flows project	0.000	-112386.281	-103106.680	-94593.284	-86782.829	-79617.275	-73043.371
Sum of discounted future cashflows =	-549529.72
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Use System B as it has lower EAC