Hagar Industrial Systems Company (HISC) is trying to decide between two differen
ID: 2652599 • Letter: H
Question
Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $260,000, has a four-year life, and requires $80,000 in pretax annual operating costs. System B costs $366,000, has a six-year life, and requires $74,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. HISC 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.
What is the EAC for each project?
Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $260,000, has a four-year life, and requires $80,000 in pretax annual operating costs. System B costs $366,000, has a six-year life, and requires $74,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. HISC 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.
Explanation / Answer
System A
Annual Depreciation = 260000/4 = 65000
pretax annual operating costs = 80000
Present Value of Total Cost = -260000 - (80000*(1-30%) + 65000*30%)*PVIFA(9%,4)
Present Value of Total Cost = - 260000 - 75500*3.239720
Present Value of Total Cost = -504,598.86
EAC = Present Value of Total Cost /PVIFA(9%,4)
EAC = -504598.86/3.239720
EAC = - $ 155,753.85
System B
Annual Depreciation = 366000/6 = 61000
pretax annual operating costs = 74000
Present Value of Total Cost = -366000 - (74000*(1-30%) + 61000*30%)*PVIFA(9%,6)
Present Value of Total Cost = - 366000 - 70100*4.485919
Present Value of Total Cost = -680,462.92
EAC = Present Value of Total Cost /PVIFA(9%,4)
EAC = -680462.92/4.485919
EAC = - $ 151,688.63
Decision : Hagar Industrial Systems Company (HISC) should choose conveyor belt systems B
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