Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. Systems A cost $24,000, has a four- year life and requires $750, 00 in pretax annual operating cost. Systems B cost $340,000 has a six-year life, and requires $69,000 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 34percent and the discount rate is 8 percent.

Calculate the NPV for both conveyor belt systems.

System A=

System B =

Which conveyor belts system should the firm choose?

Answer 1

Answer: PROJECT A

Explanation: The question clearly gives the given values. Except the fact that Pretax Annual Operating Cost should be Pretax Annual Operating Income. Treating this as an assumption to the error in question and solving further.

To calculate the Net Present Value of the project, we’ll follow the following steps:

1. The initial investment is noted along with pretax income for every year (useful life of the project)

2. The value of depreciation is calculated by dividing the initial investment by the useful life.

3. From the Pretax Income, the value of depreciation is subtracted (every year, except year 0). This gives us Profit before tax (PBT)

4. Tax calculated @34% as given in the problem is deducted from PBT to compute Profit After Taxes (PAT).

5.Depreciation value of each year (except year 0) is added back to PAT as depreciation is a non-cash expense. The value comes out is called Net Cash Flow.

6. The discount factors for each year is calculated by using the formula CF/(1+R)ⁿ. Where CF is the cash flow, R is Discount rate and n is the year.

7. Find the product of Net Cash Flow and discount factor to compute Discounted Cash Flow.

8. Add the Discounted Cash Flows of all the years (0-n) to compute NPV.

9. Accept the project with greater NPV Value (non-negative).

Since the NPV for project A is positive, we’ll accept the Project.