9. Lang Industrial Systems Company (LISC) is trying to decide between two differ

Question

9. Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $276,000, has a four-year life, and requires $84,000 in pretax annual operating costs. System B costs $390,000, has a six-year life, and requires $78,000 in pretax annual operating costs. Suppose 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.

Explanation / Answer

Operarting cash flow=(sales-cost)*(1-tax rate)+(Depreciation*tax rate)
For A:(-84000*.66)+(276000/4*0.34)=$=31,980
NPV of A=-276000-31980*[(1-(1/1.08^4)/0.08]
=$-381,921.82

For B:(-78000*.66)+(390000/6*0.34)=$=-29,380
NPV of B=-390000-29380*[(1-(1/1.08^4)/0.08]
=$-537,839.69

EAC of A=-381,921.82/[(1-(1/1.08^4)/0.08]
=-$115,310.143

EAC of B=-537,839.69/[(1-(1/1.08^4)/0.08]
=$-116,343

If the conveyor belt system will be continually replaced, we should choose system B since it has the last negative EAC.

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