Question

Matta Manufacturing is trying to decide between two different conveyor belt systems. System A costs $272,000, has a four-year life, and requires $83,000 in pretax annual operating costs. System B costs $384,000, has a six-year life, and requires $77,000 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 system is chosen, it will not be replaced when it wears out. The tax rate is 30 percent and the discount rate is 9 percent.

Calculate the NPV for both conveyor belt systems. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
  

	NPV
System A	$
System B	$

Which conveyor belt system should the firm choose?
  

• System A

• System B

Answer 1

System A

Operating cash flow = -Pre tax operating costs*(1-tax)+ Tax * depreciation

= -83000*(1-0.3) + 0.3*272000/4

=-37700

System B

Operating cash flow = -Pre tax operating costs*(1-tax)+ Tax * depreciation

= -77000*(1-0.3) + 0.3*384000/6

= -34700

	System A	System B
Year	Cash flows	Cash flows
0	-272000	-384000
1	($37,700.00)	-34700
2	($37,700.00)	-34700
3	($37,700.00)	-34700
4	($37,700.00)	-34700
5		-34700
6		-34700
NPV	($394,137.44)	($539,661.38)

NPV A = -394137.44

NPV B = -539661.38

The firm should choose System A based on the NPV since that has a higher NPV.

WORKINGS