Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $264,000, has a four-year life, and requires $81,000 in pretax annual operating costs. System B costs $372,000, has a six-year life, and requires $75,000 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 34 percent and the discount rate is 8 percent. Calculate the EAC for both conveyor belt systems.

Answer 1

Compute PV of After Tax Cashflows:

Purchase cost is capital cost & Tax benifit will not come

Operating cost is P&L item & Increases the cost, resulted into lesser Income, Leads to savngs in Tax

PV of Cashflows for System A

EAC = PV of cash flows / PVAF (r%, n)

where r is Discount rate & n is no.of years

= $ 441,066.30 / PVAF (8%, 4 years)

= $ 441,066.30 / 3.3121

= $ 133,168.17

PV of Cashflows for System B:

EAC = PV of cash flows / PVAF (r%, n)

where r is Discount rate & n is no.of years

= $ 600,832.54 / PVAF (8%, 6 years)

= $ 600,832.54 / 4.6229

= $ 129,968.75