Lang Industrial Systems Company (LISC) is trying to decide between two different
ID: 2777787 • Letter: L
Question
Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $244,000, has a four-year life, and requires $76,000 in pretax annual operating costs. System B costs $342,000, has a six-year life, and requires $70,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. The tax rate is 35 percent and the discount rate is 10 percent.
Explanation / Answer
Evaluation of projects:
Sysytem A
Year
Cash Flows (CF)
PVF(10%)
PV = CF*PVF
Initial Cost
0
$ 244,000.00
1.00000
244000
Post tax annual operating costs = 76000*(1-35%)
1 to 4
$ 49,400.00
3.16987
$156,591.35
Tax Saving on Depreciation = (244000/4)*35%
1 to 4
$ (21,350.00)
3.16987
($67,676.63)
Present value of costs (A)
$332,914.73
PVAF(10%, 4 years) (B)
3.16987
Equivalent Annual Cost = A/B
$ 105,024.88
Sysytem B
Year
Cash Flows (CF)
PVF(10%)
PV = CF*PVF
Initial Cost
0
$ 342,000.00
1.00000
342000
Post tax annual operating costs = 70000*(1-35%)
1 to 6
$ 45,500.00
4.35526
$198,164.36
Tax Saving on Depreciation = (342000/6)*35%
1 to 6
$ (19,950.00)
4.35526
($86,887.45)
Present value of costs (A)
$453,276.91
PVAF(10%, 6 years) (B)
4.35526
Equivalent Annual Cost = A/B
$ 104,075.72
We can see that Equivalent Annual Cost of System B is lower, hence system B is better.
Evaluation of projects:
Sysytem A
Year
Cash Flows (CF)
PVF(10%)
PV = CF*PVF
Initial Cost
0
$ 244,000.00
1.00000
244000
Post tax annual operating costs = 76000*(1-35%)
1 to 4
$ 49,400.00
3.16987
$156,591.35
Tax Saving on Depreciation = (244000/4)*35%
1 to 4
$ (21,350.00)
3.16987
($67,676.63)
Present value of costs (A)
$332,914.73
PVAF(10%, 4 years) (B)
3.16987
Equivalent Annual Cost = A/B
$ 105,024.88
Sysytem B
Year
Cash Flows (CF)
PVF(10%)
PV = CF*PVF
Initial Cost
0
$ 342,000.00
1.00000
342000
Post tax annual operating costs = 70000*(1-35%)
1 to 6
$ 45,500.00
4.35526
$198,164.36
Tax Saving on Depreciation = (342000/6)*35%
1 to 6
$ (19,950.00)
4.35526
($86,887.45)
Present value of costs (A)
$453,276.91
PVAF(10%, 6 years) (B)
4.35526
Equivalent Annual Cost = A/B
$ 104,075.72
We can see that Equivalent Annual Cost of System B is lower, hence system B is better.
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