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EDP is trying to decide between two different conveyor belt systems. System A costs $438,000, has a six-year life, and requires $83,000 in pretax annual operating costs. System B costs $369,000, has a five-year life, and requires $92,000 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 14.2 percent. Which system should the firm choose and why?

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The firm should choose system A because it has a six-year life and a lesser annual operating cost.                                                                  

Explanation:

  • Even though system A costs $438,000 the quality of the system is good. The quality of system A has a six-year life. So the quality is pretty good. It has an $83,000 tax annual operating cost.
  • System B costs $369,000 . Compared to the cost of system A, system B is low. But it has a $92,000 tax annual operating cost. This tax is higher than A.
  • System A has a higher life compared to system B. So the firm should choose system A.                

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