(Round answers to 2 decimal places) A manufacturing company is trying to decide
ID: 2701233 • Letter: #
Question
(Round answers to 2 decimal places)
A manufacturing company is trying to decide between two different conveyor belt systmes. System A costs $413,000, has a 4-year life, and requires $135,000 in pretax annual operating costs. System B costs $528,000, has a 7-year life, and requires $62,000 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. If the tax rate is 33 percent and the discount rate is 22 percent, the NPV for project A is $____________ and the NPV for project B is $____________. Therefore, the company should choose project A or B.
Explanation / Answer
Annual depreciation for A = 413,000/4 = 103,250.00
Annual depreciation for B = 528,000/7 = 75,528.57
Annual cost for A = operating cost + depreciation = 135000+103,250 = 238,250
Annual cost for B = operating cost + depreciation = 62000+75,528.57 = 137,428.57
Post tax annual cost for A = 238,250*(1-33%) = 159,627.50
Post tax annual cost for B = 137,428.57*(1-33%) = 92,077.14
Annual cashflow for A = depreciation - post tax annual cost = 103,250-159,627.50 = -56,377.50
Annual cashflow for B = depreciation - post tax annual cost = 75,528.57-92,077.14 = -16,648.57
NPV for A = -413,000-56,377.50/(1.22^1)-56,377.50/(1.22^2)-56,377.50/(1.22^3)-56,377.50/(1.22^4) = -553,585.22
NPV for B = -528,000-16,648.57/(1.22^1)-16,648.57/(1.22^2)-16,648.57/(1.22^3)-...-16,648.57/(1.22^6)-16,648.57/(1.22^7) = -584,863.30
As NPV of A is higher, the company should choose project A.
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