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7. Pags Industrial Systems Company (PISC) is trying to decide between two different conveyor belt systems. System A costs $525,000, has a four-year life, and requires $127,000 in pretax annual operating costs. System B costs $600,000, has a six- year life, and requires $67,500 in pretax annual operating costs. Both systems are depreciated 30% and will have no salvage value. The tax rate is 36%, and the required rate of return is 18%. (a) If the firm does not replace the equipment once it wears out, which project should PISC choose? (b) Suppose now that PISC always needs a conveyor belt system, i.e., when one wears out, it must be replaced. Which project should the firm choose then?

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2 Cost Annual cost post tax Tax shield 525000 81280 56700 -39690 -27783 -19448 81280 81 280 81280 4 Cash flow 18% 525000 24580 41590 53497 61831.9 525000 20831 29869 32560 31892 NPV 640152 183026 10 EAC 2 Cost Annual cost post tax Tax shield 43200 43200 -64800 -45360 -31752 -22226 15558 10891 43200 43200 43200 43200 16 17 18 19 20 Cash flow 18% 600000 -21600 -2160 11448 20973.6 27641.52 32309.06 600000 -18305 1551 6968 10818 12082 11968 NPV EAC 177830 The machine is more beneficiallb) t cost method eear C) 1 2 525000.00 600000.00 24580.00 -21600.00 41590.00 -2160.00 53497.00 11448.00 61831.90 20973.60 525000.00 27641.52 24580.00 32309.06 878739.48 621979.85 4 PV of cash of B is more better-C1+1 -D1+1 -E1+1 -F1+1 Annual cost post tax Tax shield s]27000(1-3696) C2309636% D3 D4.70% «ЕЗ +4.70% -F3 «F47096 -SUM(D2:D4) »D6/(1+18%)DI -SUM(G2:G4) .G6/(1+1896)G1 Cash flovw SUM(C2:C4) -c6/( 1+1896 )C1 -SUM(E2:E4) -E6/(1+1896)E1 -SUM(F2:F4) :#6/(1+18%)F1 -SUM(C7:17) -PMT( 1896,6,-C9) NPV 10 EAC 12 -C12+1 -D12+1 -E12+1 -F12+1 -G12+1 -H12+1 13 Annual cost post tax Tax shield -67500(1.36%) -D14 =D15*70% -E14 -F14 -G14 H 14 -C133056.3696 15.70% F15-70% G15*70% «H1570% 17 Cash flow SUM(C13:C15) -c17/(1+18%)^C12 «SUM(D13:D15) =D17/(1+18%)D12 ·SUM(E13:E15) -E17/(1+18%)^E12 ·SUM(F13:F15) zf17/(1+18%)F12 .SUMiG13:G15) -G17/(1+18%)G12xH17/(1+1896)4H12 .SUM(H13:H15) ·SUM(113115) =117/(1+18%)^112 18. PV@ 18% 19 20 21 NPV EAC -SUM(C18:118) =PMT( 1896,6,-C20) The machine is mor

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