Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $268,000, has a four-year life, and requires $82,000 in pretax annual operating costs. System B costs $378,000, has a six-year life, and requires $76,000 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 35 percent and the discount rate is 10 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

NPV of System A is:

OCFA= ?$82,000(1 ? .35) + .35($268,000 / 4)

OCFA= -$53,300 + $23,450 = ?$29,850

NPVA= ?$268,000 ? $23,450(PVIFA10%,4)

NPVA= -$268,000 - $23,450*3.1699 = ?$362,620.48

And the NPV of System B is:

OCFB= ?$76,000(1 ? .35) + .35($378,000 / 6)

OCFB= -$49,400 + $22,050 = ?$27,350

NPVB= ?$378,000 ? $27,350(PVIFA10%,6)

NPVB= -$378,000 - $27,350*4.3553 = ?$497,116.38

If the equipment will be replaced at the end of its useful life, the correct capital budgeting

technique is EAC. Using the above NPVs, the EAC for each system is:

EACA= –$362,620.48 / (PVIFA10%,4)

EACA= - $362,620.48 / 3.1699 = –$114,394.93

EACB= – $497,116.38 / (PVIFA10%,6)

EACB= -$497,116 / 4.3553 = –$114,140.56