Hagar Industrial Systems Company (HISC) is trying to decide between two differen

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

Hagar Industrial Systems Company All Amounts in $ EAC Calculation, Project Wise System A Years 1 2 3 4 Working of Costs Purchase Cost 200000 Operating Costs (Net of Tax) 19500 19500 19500 19500 Total Running Costs 219500 19500 19500 19500 Discount Factor @ 9% 1.00 0.92 0.84 0.77 Present Values 219500 17889.91 16412.76 15057.57786 Total Net Present Value 268860.2 To find out the EAC, this Net Present Value is to be divided by the four year annuity equivalent factor of 9% Thus, EAC for System A = $ 266,860.20 / (1.09^4) = $ 266,860.20 / 1.411582 = 189050.4 $ per year System B Years 1 2 3 4 5 6 Working of Costs Purchase Cost 282000 Operating Costs (Net of Tax) 17700 17700 17700 17700 17700 17700 Total Running Costs 299700 17700 17700 17700 17700 17700 Discount Factor @ 9% 1.00 0.92 0.84 0.77 0.71 0.65 Present Values 299700 16238.53 14897.74 13667.6476 12539.13 11503.79 Total Net Present Value 368546.8 To find out the EAC, this Net Present Value is to be divided by the six year annuity equivalent factor of 9% Thus, EAC for System A = $ 266,860.20 / (1.09^6) = $ 266,860.20 / 1.6771 = 159120 $ per year

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