Lang Industrial Systems Company (LISC) is trying to decide between two different
ID: 2761174 • Letter: L
Question
Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $240,000, has a four-year life, and requires $75,000 in pretax annual operating costs. System B costs $340,000, has a six-year life, and requires $69,000 in pretax annual operating costs. Whichever project is chosen, 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.
System A=
System B=
Explanation / Answer
We would not use tax rate here since it is all about cost and no income inflow. The equivalent annual cost can be found by using annuity formula to find teh present value and then equating it with total rearly value of P
System:
PV = 240000 + 75000(1-1.08-4) / 0.08
PV = $488409.51
The present value of EAC, P , each year would be equal to present value of cost:
$488409.51 = P(1-1.08-4) / 0.08
P = $147461
Similarly for sytem B
PV = 340000 + 69000(1-1.08-6) / 0.08
PV = $658978.69
The present value of EAC, P , each year would be equal to present value of cost:
$658978.69 = P(1-1.08-6) / 0.08
P = $142547.23
Definetely system B is better as cost is lower.
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