Question

15. Comparing Mutually Exclusive Projects Hagar Industrial Systems Company (HISCE ing to decide between two different conveyor belt systems. System A costs $265,000. hasa 4-year life, and requires $73.000 in pretax annual operating costs. System B costs $380.000 has a 6-year life, and requires $64.000 in prelax annual operating costs. Both systems to be depreciated straight line to zero over their lives and will have zero salvage value Whichever system is chosen, it will not be replaced when it wears out. If the tax rate is 23 percent and the discount rate is 7.5 percent, which system should the firm choose! 16. Comparing Mutually Exclusive Projects Suppose in the previous problem that HISC always needs a conveyor belt system: when one wears out, it must be replaced. W system should the firm choose now?

Answer 1

Answer 15)

Statement Showing Working of Present Value of Cash outflow in case of System A

Year	Net Cash Outflow W.N.1	Discount Rate @7.5%	Discounted Value
0	$265000	1	$265000
1	$40972.5	0.930	$38104.4
2	$40972.5	0.865	$35441.2
3	$40972.5	0.805	$32982.8
4	$40972.5	0.748	$30647.4

Total Present Value of Cash Outflow in System A ==========>$402175.8

WORKING NOTE 1 : NET CASH OUTFLOW

IN YEAR 0 SYSTEM A ANNUAL OUTFLOW = $265000

DEPRECIATION IS A NON CASH ITEMS. HOWEVER, TAX SAVING COULD BE POSSIBLE DUE TO THAT HENCE ANY TYPE OF SAVING IS CALLED INCOME IN THE FIELD OF FINANCE.

ANNAUL DEPRECIATION = 265000-0 =$66250
4

The salvage value is 0 given in the question.

Tax Saving Possible due to Depreciation = $66250 * tax Rate = 66250*23% = $15237.5/-

Pretax Annual Operating Cost = $73000/-(Assume that it is Other than Depreciation cost).

Tax Saving Due to Such Operating Cost Expenses : $73000*23% = $16790/-

post tax Annual Operating cost = $73000*77% = $56210

Net Post Tax Annual Operating Cost = Post Tax Annual Operating Cost - Tax SAVING DUE TO DEPRECIATION

Net Post Tax annual Operating Cost = $56210-$15237.5 = $40972.5

Statement Showing working of present Value of Cash outflow in case of System B

YEAR	NET CASH OUT FLOW W.N.2	DISCOUNT RATE@ 7.5%	DISCOUNTED VALUE
0	$380000	1	$380000
1	$34713.34	0.930	$34019.07
2	$34713.34	0.865	$30027.03
3	$34713.34	0.804	$27909.52
4	$34713.34	0.749	$26000.2
5	$34713.34	0.696	$24160.48
6	$34713.34	0.648	$22494.24

Total Present Value of Cash Outflow in System A ==========>$544610.72

WORKING NOTE 2 : NET CASH OUTFLOW

IN YEAR 0 SYSTEM A ANNUAL OUTFLOW = $380000

DEPRECIATION IS A NON CASH ITEMS. HOWEVER, TAX SAVING COULD BE POSSIBLE DUE TO THAT HENCE ANY TYPE OF SAVING IS CALLED INCOME IN THE FIELD OF FINANCE.

ANNAUL DEPRECIATION = 380000-0 =$63333.33
6

Tax Saving Possible due to Depreciation = $63333.33 * tax Rate = 63333.33*23% = $14566.66/-

Pretax Annual Operating Cost = $64000/-(Assume that it is Other than Depreciation cost).

Tax Saving Due to Such Operating Cost Expenses : $64000*23% = $14720/-

post tax Annual Operating cost = $64000*77% = $49280

Net Post Tax Annual Operating Cost = Post Tax Annual Operating Cost - Tax SAVING DUE TO DEPRECIATION

Net Post Tax annual Operating Cost = $49280-$14566.66 = $34713.34

In view of the above System A have present value of OUTFLOW IS = $402175.8

IN CASE OF SYSTEM B present value of outflow is =$544610.72

On a minute reading we found that useful life of both assets are different so, both are not comparable. so, to make it comparable we have to do as follows : Equated cash Outflow.

System a = . Present Value of Cash Outflow/ Discount Rate = $402175.8/3.348 = $120124.94

System B- Present Value of Cash Outflow/ Discount Rate = $544610.72/4.692 = $ 116072.19

So, System B should be Purchased in view of the above.

ANSWER 16) In case of mutually Exclusive product System A should be Adopted as present Value of Outflow is different.