Question

Eads Industrial Systems Company is trying to decide between two different conveyor belt systems. System A costs $427,000, has a 6-year life, and requires $112,000 in pretax annual operating costs. System B costs $517,000, has an 8-year life, and requires $79,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have a zero salvage value. The tax rate is 33 percent and the discount rate is 24 percent. Which system should the firm choose and why?

Answer 1

System A
Initial costs	427000.00
Life	6.00
Depreciation/yr	71166.67
Tax shield	23485.00
Pre tax annual cost	112000.00
Post tax annual cost	75040.00
Total annual cost adjusted for depreciation tax shield	51555.00
PV of costs @ 24%	$582,720.40
Equivalent annual costs	$192,923.67
System B
Initial costs	517000.00
Life	8.00
Depreciation/yr	64625.00
Tax shield	21326.25
Pre tax annual cost	79000.00
Post tax annual cost	52930.00
Total annual cost adjusted for depreciation tax shield	31603.75
PV of costs @ 24%	$625,123.45
Equivalent annual costs	$182,719.34
Since the equivalent annual cost of System B is lesser, we should chose system B