Hagar Industrial Systems Company (HISC) is trying to decide between two differen
ID: 2810730 • Letter: H
Question
Hagar Industrial Systems Company (HISC) 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 system is chosen, ill 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. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. A negative answer should be indicated by a minus sign.) NPV System A System B Which system should the firm choose? O System A SystemBExplanation / Answer
Solution: NPV System A -347,767.60 System B -475,196.65 System A Chosen [Should be chosen by the firm as its NPV is lower than NPV of system B of cash outflows, shows that System A will have lower cash outflows than System B. Working Notes: For computation of NPV , we have to calculate operating cash flow for each system. Since, there is no detail any revenue or sales or cash inflows so , we should calculated NPV of cash outflows , Lower the NPV of cash outflows better for the firm. System A OCF for A = pretax annual operating costs x ( 1 - tax rate ) + tax saving on depreciation OCF for A = -$79,000 x ( 1 - 0.35 ) + tax rate x (system cost/life) OCF for A = -$51,350 + 0.35 x (256,000/4) OCF for A = -$51,350 + 22,400 OCF for A = -$28,950 -ve shows cash outflows NPV for A = system cost + OCF A x (PVIFA 10% , 4) NPV for A = -$256,000 -$28,950 x 3.169865446 NPV for A =-347,767.6046617 NPV for A = -347,767.60 (PVIFA 10% , 4) is calculated = (1 - (1/(1 + 0.10)^4) ) /0.10 = 3.169865446 System B OCF for B = pretax annual operating costs x ( 1 - tax rate ) + tax saving on depreciation OCF for B = -$73,000 x ( 1 - 0.35 ) + tax rate x (system cost/life) OCF for B = -$47,450 + 0.35 x (360,000/6) OCF for B = -$47,450 + 21,000 OCF for B = -$26,450 -ve shows cash outflows NPV for B = system cost + OCF B x (PVIFA 10% , 6) NPV for B = -$360,000 -$26,450 x 4.355260699 NPV for B =-475,196.6455 NPV for B = -475,196.65 (PVIFA 10% , 6) is calculated = (1 - (1/(1 + 0.10)^6) ) /0.10 = 4.355260699 Please feel free to ask if anything about above solution in comment section of the question.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.