Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $236,000, has a four-year life, and requires $74,000 in pretax annual operating costs. System B costs $336,000, has a six-year life, and requires $68,000 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 30 percent and the discount rate is 9 percent. Calculate the EAC for both conveyor belt systems. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

System A

Time line		0	1	2	3	4
Cost of new machine		-236000
=Initial Investment outlay		-236000
							100.00%
Sales			0	0	0	0
Profits	Sales-variable cost		0	0	0	0
Operating cost			-74000	-74000	-74000	-74000
-Depreciation	Cost of equipment/no. of years		-59000	-59000	-59000	-59000	0	=Salvage Value
=Pretax cash flows			-133000	-133000	-133000	-133000
-taxes	=(Pretax cash flows)*(1-tax)		-93100	-93100	-93100	-93100
+Depreciation			59000	59000	59000	59000
=after tax operating cash flow			-34100.00	-34100.00	-34100	-34100
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						0
Total Cash flow for the period		-236000	-34100.00	-34100.00	-34100.000	-34100
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816
Discounted CF=	Cashflow/discount factor	-236000	-31284.40367	-28701.28777	-26331.45667	-24157.3
NPV=	Sum of discounted CF=	-346474.45

Year or period		0	1	2	3	4
EAC			-106945.8049	-106945.8049	-106945.8049	-106945.8
Discount factor=	(1+discount rate)^corresponding period		1.09	1.1881	1.295029	1.4115816
Discounted CF=	Cashflow/discount factor		-98115.41737	-90014.14437	-82581.78383	-75763.1
NPV=	-346474.45
EAC is equivalent yearly CF with same NPV =	-106945.85

System B

Time line		0	1	2	3	4	5	6
Cost of new machine		-336000
=Initial Investment outlay		-336000
									100.00%
Sales			0	0	0	0	0	0
Profits	Sales-variable cost		0	0	0	0	0	0
Operating cost			-68000	-68000	-68000	-68000	-68000	-68000
-Depreciation	Cost of equipment/no. of years		-56000	-56000	-56000	-56000	-56000	-56000	0	=Salvage Value
=Pretax cash flows			-124000	-124000	-124000	-124000	-124000	-124000
-taxes	=(Pretax cash flows)*(1-tax)		-86800	-86800	-86800	-86800	-86800	-86800
+Depreciation			56000	56000	56000	56000	56000	56000
=after tax operating cash flow			-30800.00	-30800.00	-30800	-30800	-30800	-30800
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
Total Cash flow for the period		-336000	-30800.00	-30800.00	-30800.000	-30800	-30800	-30800
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816	1.538624	1.6771001
Discounted CF=	Cashflow/discount factor	-336000	-28256.88073	-25923.74379	-23783.25119	-21819.5	-20017.89	-18365.03
NPV=	Sum of discounted CF=	-474166.29

Year or period		0	1	2	3	4	5	6
EAC			-105701.0466	-105701.0466	-105701.0466	-105701	-105701	-105701
Discount factor=	(1+discount rate)^corresponding period		1.09	1.1881	1.295029	1.4115816	1.538624	1.6771001
Discounted CF=	Cashflow/discount factor		-96973.43726	-88966.4562	-81620.60202	-74881.29	-68698.43	-63026.08
NPV=	-474166.29
EAC is equivalent yearly CF with same NPV =	-105701.05