Lang Industrial Systems Company (LISC) is trying to decide between two different
ID: 2653630 • Letter: L
Question
Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $256,000, has a four-year life, and requires $79,000 in pretax annual operating costs. System B costs $360,000, has a six-year life, and requires $73,000 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 35 percent and the discount rate is 10 percent.
Calculate the NPV for both conveyor belt systems.
NPV
Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $256,000, has a four-year life, and requires $79,000 in pretax annual operating costs. System B costs $360,000, has a six-year life, and requires $73,000 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 35 percent and the discount rate is 10 percent.
Explanation / Answer
Solution:
Computation of NPV
The information giben in trhe question doesnot specify, whether Operating costs are after depreciatioon or before Depreciation. therefore by both ways calculation of NPV is done.
1. Operating Costs are after Depreciation
Particulars
System A
System B
Initial Investment
256000
360000
Annual Operating costs pre-tax
79000
73000
After tax Annual Operating costs
51350
47450
Annual Depreciation
64000
60000
Cash inflow after adding Depreciation
12,650
12,550
PVAF @ 10 %
3.1698
4.355
Present Value of Cash inflows
40097.97
54655.25
NPV
= Present Value of Cash inflows - Initial Investment
= Present Value of Cash inflows - Initial Investment
= 40098 – 256000 = -215,902
= 54655 – 360000 = - 305,345
Decision, project with more NPV should be selected
This Project should be selected
This Project should not be selected
2. 1. Operating Costs are before Depreciation
Particulars
System A
System B
Initial Investment
256000
360000
Annual Operating costs pre-tax
79000 + 64,000 = 143,000
73000 + 60,000 = 133,000
After tax Annual Operating costs
= 92,950
= 86,450
Annual Depreciation
64000
60000
Cash outflow after adding Depreciation
= 28,950
= 26,450
PVAF @ 10 %
3.1698
4.355
Present Value of Cash outflows
91,766
115,190
NPV
= Present Value of Cash inflows - ( Initial Investment + Present Value of cash outflows )
= Present Value of Cash inflows - ( Initial Investment + Present Value of cash outflows )
= 0 – 256,000 + 91,766 = - $ 347,766
= 0 – 360000 + 115,190 = - $ 475,190
Decision, project with more NPV should be selected
This Project should be selected
This Project should not be selected
Particulars
System A
System B
Initial Investment
256000
360000
Annual Operating costs pre-tax
79000
73000
After tax Annual Operating costs
51350
47450
Annual Depreciation
64000
60000
Cash inflow after adding Depreciation
12,650
12,550
PVAF @ 10 %
3.1698
4.355
Present Value of Cash inflows
40097.97
54655.25
NPV
= Present Value of Cash inflows - Initial Investment
= Present Value of Cash inflows - Initial Investment
= 40098 – 256000 = -215,902
= 54655 – 360000 = - 305,345
Decision, project with more NPV should be selected
This Project should be selected
This Project should not be selected
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