Question

Matta Manufacturing is trying to decide between two different conveyor belt systems. System A costs $212,000, has a four-year life, and requires $68,000 in pretax annual operating costs. System B costs $300,000, has a six-year life, and requires $62,000 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 30 percent and the discount rate is 9 percent.Matta Manufacturing is trying to decide between two different conveyor belt systems. System A costs $212,000, has a four-year life, and requires $68,000 in pretax annual operating costs. System B costs $300,000, has a six-year life, and requires $62,000 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 30 percent and the discount rate is 9 percent. Calculate the EAC for both conveyor belt systems.

Answer 1

Calcualtion of equivalent annual cost of system A and B -

	Year	0	1	2	3	4
	Initial Cost	212000
	annual operating cost		68000	68000	68000	68000
	Dep.		53000	53000	53000	53000
	Total Expenses		121000	121000	121000	121000
	Tax Shield @30%		36300	36300	36300	36300
	Earning after tax	212000	84700	84700	84700	84700
add	Dep.		53000	53000	53000	53000
	Cash outflow	212000	31700	31700	31700	31700
	Interest rate @ 9 %	1	0.917431	0.84168	0.772183	0.708425	3.23972
	PV	212000	29082.57	26681.26	24478.22	22457.08	314699.1

Equivalent annual cost of system A = 314699.1/3.23972

= 97137.76

	Year	0	1	2	3	4	5	6
	Initial Cost	300000
	annual operating cost		62000	62000	62000	62000	62000	62000
	Dep.		50000	50000	50000	50000	50000	50000
	Total Expenses		112000	112000	112000	112000	112000	112000
	Tax Shield @30%		33600	33600	33600	33600	33600	33600
	Earning after tax	300000	78400	78400	78400	78400	78400	78400
add	Dep.		50000	50000	50000	50000	50000	50000
	Cash out flow	300000	28400	28400	28400	28400	28400	28400
	Interest rate @ 9 %	1	0.917431	0.84168	0.772183	0.708425	0.649931	0.596267	4.485919
	PV	300000	26055.05	23903.71	21930.01	20119.28	18458.05	16933.99	427400.1

Equivalent annual cost = NPV/ PVIFA(9%,6)

= 427400.1/4.485919

= 95275.93

Please comment in case of any clarification required.