Problem 10-20 Comparing Mutually Exclusive Projects [LO1] Lang Industrial System
ID: 2644840 • Letter: P
Question
Problem 10-20 Comparing Mutually Exclusive Projects [LO1] Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $264,000, has a four-year life, and requires $81,000 in pretax annual operating costs. System B costs $372,000, has a six-year life, and requires $75,000 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. Calculate the NPV for both conveyor belt systems. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) NPV System A $ System B $Explanation / Answer
Here we should calculate the Equivalent annual cost (EAC) as capital cost and Operating expenses are given.
The EAC is = NPV/At,r
Where,
T = time of project
R = cost of capital
For system A = $264000/A4,8 + Pretax Operating cost
=$264000/3.3121 + $81000
=$79708 + $81000
=$160708
For system A = $372000/A6,8 + Pretax Operating cost
=$372000/4.6229 + $75000
=$80469 + $75000
=$155469
Therefore, you should go for System B as the Equivalent cost is less for the System B.
There would be no impact of taxes on evaluation of project as the rate of tax is same for both systems.
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