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Homework answers / question archive / EDP is trying to decide between two different conveyor belt systems
EDP is trying to decide between two different conveyor belt systems. System A costs $320,000, has a four-year life, and requires $85,000 in pretax annual operating costs. System B costs $456,000, has a six-year life, and requires $54,000 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. Whichever system is chosen, it will not be replaced when it wears out. The tax rate is 23 percent and the discount rate is 12.5 percent.
What is the OCF for System A?
What is the OCF for System B?
Which system should the firm choose?
OCF of system A;
Operating Cash Flow = Pre-tax annual operating costs(1 - Tax Rate) + [Depreciation Expense x Tax Rate]
= -$85,000* (1 - 0.23) + [($320,000/4 Years) x 0.23]
= -$65,450 + $18,400
= -$47,050
OCF of system B;
Operating Cash Flow = Pre-tax annual operating costs(1 - Tax Rate) + [Depreciation Expense x Tax Rate]
= -$54,000* (1 - 0.23) + [($456,000/6 Years) x 0.23]
= -$41,580 + $17,480
= -$24,100
Firm should choose system B because it has lower OCF.
