Please provide details for full credits 2 points/question for correct answer ony

Question

Please provide details for full credits 2 points/question for correct answer ony 1. (10 points) Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $290,000, has a four-year life, and requires $85,000 in pretax annual operating costs. System B costs $405,000, has a six- year life, and requires $75,000 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 when a conveyor belt system wears out, it must be replaced. If the tax rate is 34 percent and the discount rate is 11 percent, which system should the firm choose and why?

Explanation / Answer

System A

operating cash flow = 85000 * (1-0.34) - 0.34 * (290000 / 4 years)

= 56100 - 24650

= 31450

Total Present value of operating cash flow = - 290000 - 31450 * PVAF(11%,4years).

= -290000 - (31450 * 3.1024)

=- 290000 - 97570.48

= - 387570.48

System B

operating cash flow = 75000 * (1-0.34) - 0.34 * (405000 / 6 years)

= 49500 - 22950

=26550

Total Present value of operating cash flow = - 405000 - 26550 * PVAF(11%,6years).

= -405000 - (26550 * 4.2305)

= -405000 - 112319.78

= -517319.78

System A should be chosen,because its present value of operating cash flow is less than system B

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