Lang Industrial Systems Company (LISC) is trying to decide between two different
ID: 2713547 • Letter: L
Question
Lang Industrial Systems Company (LISC) 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. 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.
Lang Industrial Systems Company (LISC) 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. 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.
Explanation / Answer
System A Time line 0 1 2 3 4 Cost of equipment -260000 Installation cost 0 Total investment in new machine -260000 =Initial Investment outlay -260000 operating cost -80000 -80000 -80000 -80000 -Depreciation Cost of equipment/4 -65000 -65000 -65000 -65000 0 =Salvage book value = -145000 -145000 -145000 -145000 -taxes =(cost- depreciation)*(1-tax) -101500 -101500 -101500 -101500 +Depreciation 65000 65000 65000 65000 =after tax operating cash flow -36500 -36500 -36500 -36500 Proceeds from sale of assets =salvage value*(1 - tax rate) 0 +Salvage book value * tax rate 0 Terminal year non operating cash flows 0 Total Cash flow for the period -260000 -36500 -36500 -36500 -36500 Discount factor =(1+discount rate)^n 1 1.09 1.1881 1.295029 1.411582 Discount rate= 9% Discounted cash flows -260000 -33486.2 -30721.3 -28184.7 -25857.5 NPV= Sum of discounted cash flows -378250 EAC = -116753.9214 -116754 -116754 -116754 -116754 Discounted EAC -107114 -98269.4 -90155.4 -82711.4 Sum of discounted EAC=NPV= -378250 System B Time line 0 1 2 3 4 5 6 Cost of equipment -366000 Installation cost 0 Total investment in new machine -366000 =Initial Investment outlay -366000 operating cost -74000 -74000 -74000 -74000 -74000 -74000 -Depreciation = Cost of equipment/6 -61000 -61000 -61000 -61000 -61000 -61000 0 =Salvage book value = -135000 -135000 -135000 -135000 -135000 -135000 -taxes =(cost- depreciation)*(1-tax) -94500 -94500 -94500 -94500 -94500 -94500 +Depreciation 61000 61000 61000 61000 61000 61000 =after tax operating cash flow -33500 -33500 -33500 -33500 -33500 -33500 Proceeds from sale of assets =salvage value*(1 - tax rate) 0 +Salvage book value * tax rate 0 Terminal year non operating cash flows 0 Total Cash flow for the period -366000 -33500 -33500 -33500 -33500 -33500 -33500 Discount factor =(1+discount rate)^n 1 1.09 1.1881 1.295029 1.411582 1.538624 1.6771 Discount rate= 9% Discounted cash flows -366000 -30733.9 -28196.3 -25868.1 -23732.2 -21772.7 -19975 NPV= Sum of discounted cash flows -516278 EAC = -115088.5799 -115089 -115089 -115089 -115089 -115089 -115089 Discounted EAC -105586 -96867.8 -88869.5 -81531.7 -74799.7 -68623.6 Sum of discounted EAC=NPV= -516278
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