Question

In: Finance

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System...

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $355,000, has a four-year life, and requires $145,000 in pretax annual operating costs. System B costs $435,000, has a six-year life, and requires $139,000 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 23 percent and the discount rate is 9 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.)

Solutions

Expert Solution

System A

Time line 0 1 2 3 4
Cost of new machine -355000
=Initial Investment outlay -355000
Sales 0 0 0 0
Profits Sales-variable cost 0 0 0 0
Operating cost -145000 -145000 -145000 -145000
-Depreciation Cost of equipment/no. of years -88750 -88750 -88750 -88750
=Pretax cash flows -233750 -233750 -233750 -233750
-taxes =(Pretax cash flows)*(1-tax) -179988 -179988 -179987.5 -179987.5
+Depreciation 88750 88750 88750 88750
=after tax operating cash flow -91237.5 -91237.5 -91237.5 -91237.5
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -355000 -91237.5 -91237.5 -91237.5 -91237.5
Discount factor= (1+discount rate)^corresponding period 1 1.09 1.1881 1.295029 1.4115816
Discounted CF= Cashflow/discount factor -355000 -83704.1 -76792.8 -70452.09 -64634.95
NPV= Sum of discounted CF= -650583.94

System B

Time line 0 1 2 3 4 5 6
Cost of new machine -435000
=Initial Investment outlay -435000
Sales 0 0 0 0 0 0
Profits Sales-variable cost 0 0 0 0 0 0
Operating cost -139000 -139000 -139000 -139000 -139000 -139000
-Depreciation Cost of equipment/no. of years -72500 -72500 -72500 -72500 -72500 -72500
=Pretax cash flows -211500 -211500 -211500 -211500 -211500 -211500
-taxes =(Pretax cash flows)*(1-tax) -162855 -162855 -162855 -162855 -162855 -162855
+Depreciation 72500 72500 72500 72500 72500 72500
=after tax operating cash flow -90355 -90355 -90355 -90355 -90355 -90355
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -435000 -90355 -90355 -90355 -90355 -90355 -90355
Discount factor= (1+discount rate)^corresponding period 1 1.09 1.1881 1.295029 1.4115816 1.538624 1.6771001
Discounted CF= Cashflow/discount factor -435000 -82894.5 -76050 -69770.64 -64009.76 -58724.55 -53875.73
NPV= Sum of discounted CF= -840325.17

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