Hagar Industrial Systems Company (HISC) is trying to decide between two differen
ID: 2725611 • 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?
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.
Explanation / Answer
System A
Years
cost
Post tax operating cost
(1-tax rate)* operating cost
Tax saving on depreciation
Total cashflow
Dis factor @9%
Discounted cashflow
0
-200000
-200000
1
-200000
1
-45500
15000
-30500
0.917
-27,981.65
2
-45500
15000
-30500
0.842
-25,671.24
3
-45500
15000
-30500
0.772
-23,551.60
4
-45500
15000
-30500
0.708
-21,606.97
3.240
-2,98,811.46
EAC
298811/3.240
-92,233.73
Dpreciation
200000/4
50000
Tax saving on depreciation
50000*tax rate
15000
System B
Years
Cost
Post tax operating cost
(1-tax rate)* operating cost
Tax saving on depreciation
Total cashflow
Dis factor @9%
Discounted cashflow
0
-282000
-282000
1
-282000
1
-41300
14100
-27200
0.917
-24,954.13
2
-41300
14100
-27200
0.842
-22,893.70
3
-41300
14100
-27200
0.772
-21,003.39
4
-41300
14100
-27200
0.708
-19,269.17
5
-41300
14100
-27200
0.650
-17,678.13
6
-41300
14100
-27200
0.596
-16,218.47
4.486
-4,04,016.99
EAC
404016/4.486
-90,063.38
Dpreciation
282000/6
47000
Tax saving on depreciation
50000*tax rate
14100
Years
cost
Post tax operating cost
(1-tax rate)* operating cost
Tax saving on depreciation
Total cashflow
Dis factor @9%
Discounted cashflow
0
-200000
-200000
1
-200000
1
-45500
15000
-30500
0.917
-27,981.65
2
-45500
15000
-30500
0.842
-25,671.24
3
-45500
15000
-30500
0.772
-23,551.60
4
-45500
15000
-30500
0.708
-21,606.97
3.240
-2,98,811.46
EAC
298811/3.240
-92,233.73
Dpreciation
200000/4
50000
Tax saving on depreciation
50000*tax rate
15000
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