Question

Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $365,000, has a 4-year life, and requires $153,000 in pretax annual operating costs. System B costs $445,000, has a 6-year life, and requires $147,000 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 25 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.)

Which conveyor belt system should the firm choose?

System A System B

Answer 1

System A :-

NPV = - Initial cost – (Annual operating cost after tax * PVAF) + (Depreciation Tax Shield * PVAF)

Initial cost = $365000

Annual operating cost after tax = $153000 * 75% = $114750

Depreciation Tax shield = ($365000/4 years) * Tax rate

                = $91250 * 25% = $22812.5

PVAF (11%, 4 years) = 3.1024

= -$365000 – ($114750 * 3.1024) + ($22812.5 * 3.1024)

= -$365000 - $356000.4 + $70773.5 = -$650226.9

System B :-

NPV = - Initial cost – (Annual operating cost after tax * PVAF) + (Depreciation Tax Shield * PVAF)

Initial cost = $445000

Annual operating cost after tax = $147000 * 75% = $110250

Depreciation Tax shield = ($445000/6 years) * Tax rate

                = $74166.67 * 25% = $18541.67

PVAF (11%, 6 years) = 4.2305

= -$445000 – ($110250 * 4.2305) + ($18541.67 * 4.2305)

= -$445000 - $466412.63 + $78440.53 = -$832972.10

EAC for System A = -$650226.9/3.1024 = -$209588.35

EAC for system B = -$832972.10/4.2305 = -$196896.84

The firm choose System B