Hagar Industrial Systems Company (HISC) is trying to decide between two differen
ID: 2724994 • Letter: H
Question
Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $200,000, has a four-year life, and requires $65,000 in pretax annual operating costs. System B costs $282,000, has a six-year life, and requires $59,000 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 using aftertax cash flows?
Explanation / Answer
System A
Annual depreciation = cost of asset / life
= 200,000 / 4
= 50,000
Annual cash flow = Depreciation x t – annual operating cost x (1-t)
= 50,000 x 30% - 65000 x (1-0.30)
= 15000 – 45500
= -30,500
EAC= ( annual cash flow x PVIFA(4, 9%) – initial Investment)/ PVIFA(4,9%)
= (-30,500 x 3.2397199 – 200,000)/ 3.2397199
= 92233.73
System B
Annual depreciation = cost of asset / life
= 282,000 / 6
= 47,000
Annual cash flow = Depreciation x t – annual operating cost x (1-t)
= 47,000 x 30% - 59000 x (1-0.30)
= 14100 – 41300
= -27200
EAC= ( annual cash flow x PVIFA(6, 9%) – initial Investment)/ PVIFA(6,9%)
= (-27,200 x 4.4859 – 282,000)/ 4.4859
= 90063.64
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