Letang Industrial Systems Company (LISC) is trying to decide between two differe

Question

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $265,000, has a four-year life, and requires $73,000 in pretax annual operating costs. System B costs $345,000, has a six-year life, and requires $67,000 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 21 percent and the discount rate is 8 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.) System A System B

Explanation / Answer

As the NPV of cost of System A is lower, we would go with System A.

Working is shown below:

System A System B Comment Cost ($) 265000 345000 Useful Life (Years) 4 6 Depreciation per year ($) 66250 57500 Cost/Useful Life Tax Rate 21% 21% Tax Shield due to Depreciation             13,913             12,075 Tax Rate*Depreciation Per Year Pre tax Annual Cost 73000 67000 Annual cost after Tax 57670 52930 Pre tax Annual cost*(1-tax rate) Total Cost net of Depreciation             43,758             40,855 Annual cost net of Depreciation - Tax Shield due to Depreciation PV of the costs at 8 percent discount rate $409,930.39 $533,867.75 Cost + PV of Total cost net of Depreciation

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