Question

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $265,000, has a four-year life, and requires $73,000 in pretax annual operating costs. System B costs $345,000, has a six-year life, and requires $67,000 in pretax annual operating costs. The company always needs a conveyor belt system; when one wears out, it must be replaced. Assume the tax rate is 21 percent and the discount rate is 8 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.)

Answer 1

Answer:

System A EAC = -$137,679.01

System B EAC = -$127,558.81

Explanation:

Denote i = discount rate = 8%; n= number of compounding period

For system A, the after tax cost of operation is 73,000 x (1-21%) = 57,670

- NPV of system A = -265,000 - [ 57,670/8%] / [ 1 - (1+8%)^-4] = -$456,010.3549

- EAC = ( NPV x i ) / [ 1 - (1+i)^-n) = (-456,010.3549 x 8%) / ( 1 - 1.08^-4) = -$137,679.01

For system B, the after tax cost of operation is 67,000 x (1-21%) = 52,930

- NPV of system B = -345,000 - [ 52,930/8%] / [ 1 - (1+8%)^-6] = -$589,689.0206

- EAC = ( NPV x i ) / [ 1 - (1+i)^-n) = (-589,689.0206 x 8%) / ( 1 - 1.08^-6) = -$127,558.81