Question

Blooper Industries must replace its magnoosium purification system. Quick & Dirty Systems sells a relatively cheap purification system for $10 million. The system will last 5 years. Do-It-Right sells a sturdier but more expensive system for $12 million, it will last for 8years. Both systems entail $1 million in operating costs; both will be depreciated in an asset class that has a CCA rate of 30%; 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%. Which system should blooper install?

Answer 1

Do-It-Right sturdier is cheaper in terms of costs incurred calculated using NPV analysis

	Quick & Dirty Systems	Do-It-Right
Year	Operating cost (net of taxes)	Depreciation	Tax saving on depreciation	Total cost	Discounting factor	NPV	Depreciation	Tax saving on depreciation	Total cost	Discounting factor	NPV
1	0.65	3	1.05	-0.4	0.892857143	-0.35714	3.6	1.26	-0.61	0.89285714	-0.54464
2	0.65	2.1	0.735	-0.085	0.797193878	-0.06776	1.92	0.672	-0.022	0.79719388	-0.01754
3	0.65	1.47	0.5145	0.1355	0.711780248	0.096446	1.344	0.4704	0.1796	0.71178025	0.127836
4	0.65	1.029	0.36015	0.28985	0.635518078	0.184205	0.9408	0.32928	0.32072	0.63551808	0.203823
5	0.65	0.7203	0.252105	0.397895	0.567426856	0.225776	0.65856	0.230496	0.419504	0.56742686	0.238038
6	0.65				0.506631121		0.460992	0.1613472	0.4886528	0.50663112	0.247567
7	0.65				0.452349215		0.3226944	0.11294304	0.53705696	0.45234922	0.242937
8	0.65				0.403883228		0.22588608	0.079060128	0.57093987	0.40388323	0.230593
						0.081523					0.728613

NPV of cash outlows in case of Quick & dirty systems = 10+0.081523

This should be annualised, therefore annualised PV of cash outflows = 10.081523/3.604776

=> 2.796713 million

NPV of cash outlows in case of Do-It-Right = 12+ 0.728613

This should be annualised, therefore annualised PV of cash outflows = 12.728613/ 4.96764

=>2.562306 million

Accordingly, do-it-right must be selected.