Question

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $305,000, has a four-year life, and requires $105,000 in pretax annual operating costs. System B costs $385,000, has a six-year life, and requires $99,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. The tax rate is 23 percent and the discount rate is 11 percent.

Calculate the NPV for both conveyor belt systems. (A negative answer 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

System A

Time line		0	1	2	3	4
Cost of new machine		-305000
=Initial Investment outlay		-305000
							100.00%
Sales			0	0	0	0
Profits	Sales-variable cost		0	0	0	0
Operating cost			-105000	-105000	-105000	-105000
-Depreciation	Cost of equipment/no. of years		-76250	-76250	-76250	-76250	0	=Salvage Value
=Pretax cash flows			-181250	-181250	-181250	-181250
-taxes	=(Pretax cash flows)*(1-tax)		-139562.5	-139562.5	-139562.5	-139562.5
+Depreciation			76250	76250	76250	76250
=after tax operating cash flow			-63312.5	-63312.5	-63312.5	-63312.5
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						0
Total Cash flow for the period		-305000	-63312.5	-63312.5	-63312.5	-63312.5
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704
Discounted CF=	Cashflow/discount factor	-305000	-57038.2883	-51385.8453	-46293.5543	-41705.9
NPV=	Sum of discounted CF=	-501423.59

System B

Time line		0	1	2	3	4	5	6
Cost of new machine		-385000
=Initial Investment outlay		-385000
									100.00%
Sales			0	0	0	0	0	0
Profits	Sales-variable cost		0	0	0	0	0	0
Operating cost			-99000	-99000	-99000	-99000	-99000	-99000
-Depreciation	Cost of equipment/no. of years		-64166.6667	-64166.6667	-64166.6667	-64166.67	-64166.67	-64166.67	0	=Salvage Value
=Pretax cash flows			-163166.667	-163166.667	-163166.667	-163166.7	-163166.7	-163166.7
-taxes	=(Pretax cash flows)*(1-tax)		-125638.333	-125638.333	-125638.333	-125638.3	-125638.3	-125638.3
+Depreciation			64166.66667	64166.66667	64166.66667	64166.667	64166.667	64166.667
=after tax operating cash flow			-61471.67	-61471.67	-61471.67	-61471.67	-61471.67	-61471.67
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
Total Cash flow for the period		-385000	-61471.67	-61471.67	-61471.67	-61471.67	-61471.67	-61471.67
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704	1.6850582	1.8704146
Discounted CF=	Cashflow/discount factor	-385000	-55379.8829	-49891.7864	-44947.5553	-40493.29	-36480.44	-32865.27
NPV=	Sum of discounted CF=	-645058.23