Question

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $335,000, has a four-year life, and requires $129,000 in pretax annual operating costs. System B costs $415,000, has a six-year life, and requires $123,000 in pretax annual operating costs. Suppose the company always needs a conveyor belt system; when one wears out, it must be replaced. Assume the tax rate is 24 percent and the discount rate is 9 percent.

Calculate the EAC for both conveyor belt systems. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

System A
System B

Answer 1

System A:

Cost of Machine = $335,000
Useful Life = 4 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $335,000 / 4
Annual Depreciation = $83,750

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$129,000 * (1 - 0.24) + 0.24 * $83,750
Annual OCF = -$77,940

NPV = -$335,000 - $77,940 * PVIFA(9%, 4)
NPV = -$335,000 - $77,940 * 3.23972
NPV = -$587,503.7768

EAC = NPV / PVIFA(9%, 4)
EAC = -$587,503.7768 / 3.23972
EAC = -$181,344.00

System B:

Cost of Machine = $415,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $415,000 / 6
Annual Depreciation = $69,166.67

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$123,000 * (1 - 0.24) + 0.24 * $69,166.67
Annual OCF = -$76,880.00

NPV = -$415,000 - $76,880 * PVIFA(9%, 6)
NPV = -$415,000 - $76,880 * 4.48592
NPV = -$759,877.5296

EAC = NPV / PVIFA(9%, 6)
EAC = -$759,877.5296 / 4.48592
EAC = -$169,391.68