Question

Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $290,000, has a four-year life, and requires $80,000 in pretax annual operating costs. System B costs $375,000, has a six-year life, and requires $74,000 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 34 percent and the discount rate is 8 percent, which project should the firm choose?

Answer 1

Project-A
Annual cash outflows				-80000
Less: Tax benefit on outflows @ 34%				27200
Less: tax benefit on Depreciation @34%				24650
(Annual depreciation = 290,000/4)
Net Annual Cash outflows				-28150
PVF at 8% for 4 years				3.3121
Present value of cash outflows				-93235.6
Add: Initial Investment				-290,000
Total Present value of cash outflows				-383235
Annuity Factor				3.3121
Annualised Cash inflows				-115708
Project-B
Annual cash outflows				-74000
Less: Tax benefit on outflows @ 34%				25160
Less: tax benefit on Depreciation @34%				21250
(Annual depreciation = 375,000/6)
Net Annual Cash outflows				-27590
PVF at 8% for 4 years				4.6229
Present value of cash outflows				-127546
Add: Initial Investment				-375,000
Total Present value of cash outflows				-502546
Annuity Factor				4.6229
Annualised Cash inflows				-108708
As, the annualised cash outflow of project-B is lesser. Hence, Project B shall be accepted