Blooper Industries must replace its magnoosium purification system. Quick & Dirt
ID: 2745552 • Letter: B
Question
Blooper Industries must replace its magnoosium purification system. Quick & Dirty Systems sells a relatively cheap purification system for $12 million. The system will last 4 years. Do-It-Right sells a sturdier but more expensive system for $20 million; it will last for 8 years. Both systems entail $2 million in operating costs; both will be depreciated straight-line to a final value of zero over their useful lives; neither will have any salvage value at the end of its life. The firm’s tax rate is 35%, and the discount rate is 12%. Either machine will be replaced at the end of its life. a. Calculate the equivalent annual cost of each alternative: (Do not round intermediate calculations. Enter your answers as a positive value. Enter your answers in whole dollars, not in millions.) Equivalent Annual Cost Quick & Dirty $ Do-It-Right b. Which system should Blooper install? Quick & Dirty Do-It-Right
Explanation / Answer
Quick & Dirty Systems Do-It-Right Initial Investment $12,000,000 $20,000,000 Useful Life 4 8 years Operating costs $2,000,000 $2,000,000 Tax rate 35.00% Discount rate 12.00% Depreciation = Investment /useful life $3,000,000 $2,500,000 Depreciation Tax Shield (Dep x 35%) $1,050,000 $875,000 Present Value of Depreciation tax shield = Dep.Tax Shield xPVIFA(12%,useful life) $3,189,216.81 $4,346,684.8 Net Capital Cost = Investment PV(depreciation tax shield) $8,810,783.19 $15,653,315.2 EAC = PMT(12, usefullife,-net capital cost) $2,900,813.24 $3,151,056.83 EAC Quick & Dirty Systems PMT(12%,4,-$2900813.24) $2,900,813.24 Do-It-Right PMT(12%,8,-$3151056.83) $3,151,056.83 b) Blooper install Quick and dirt system because it has lower EAC.