Question

Kingsmill Industrial Systems Company (KISC) is trying to decide between two different conveyor belt systems. System A costs $360,000, has a four-year life, and requires $135,000 in pre-tax annual operating costs. System B costs $430,000, has a six-year life, and requires $98,000 in pre-tax annual operating costs. Both systems are to be depreciated at 30 percent per year (Class 10) and will have no salvage value. Whichever project is chosen, it will not be replaced when it wears out. If the tax rate is 34 percent and the discount rate is 12 percent, which project should the firm choose
Suppose in the previous problem that KISC always needs a conveyor belt system; when one wears out, it must be replaced. Which project should the firm choose now?

Answer 1

Cash flow for project A and its NPV is :

year	income	depreciation	tax	cash flow	PV
0	-360000	0	0	-360000	-360000
1	-135000	108000	-82620	-52380	-46767.9
2	-135000	108000	-82620	-52380	-41757
3	-135000	108000	-82620	-52380	-37283
4	-135000	108000	-82620	-52380	-33288.4
NPV					-519096

Cash flow for project B and its NPV is :

year	income	depreciation	tax	cash flow	PV
0	-430000	0	0	-430000	-430000
1	-98000	129000	-77180	-20820	-18589.3
2	-98000	129000	-77180	-20820	-16597.6
3	-98000	129000	-77180	-20820	-14819.3
4	-98000	129000	-77180	-20820	-13231.5
5	-98000	129000	-77180	-20820	-11813.8
6	-98000	129000	-77180	-20820	-10548.1
NPV					-515600

As it can be seen that NPV, i.e. cash outlay of project B is less than Project A. so Project B must be choosen.