Question

Matta Manufacturing is trying to decide between two different conveyor belt systems. System A costs $244,000, has a four-year life, and requires $76,000 in pretax annual operating costs. System B costs $342,000, has a six-year life, and requires $70,000 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, it will 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. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) NPV System A System B

Answer 1

System A:

cost of system = 244,000

useful life = 4 years

Depreciation = 244,000 / 4 = 61,000

pretax annual operating costs = 76,000

tax = 35%

Annual operating cash flow = -pretax annual operating cost(1 - tax) + depreciation * tax rate

= -76,000(1 - 0.35) + 61,000 * 0.35

= -49,400 + 21350

= -28,050

(note: amount of $76,000 is out flow that's why we have taken negative sign)

discount rate = 10%

PVIFA( n = 4 ; r = 10%) = 3.16986544

NPV = -244,000 - 28,050 * 3.16986544

= -332914.73

System B:

cost of system = 342,000

useful life = 6 years

Depreciation = 342,000 / 6 = 57,000

pretax annual operating costs = 70,000

tax = 35%

Annual operating cash flow = -pretax annual operating cost(1 - tax) + depreciation * tax rate

= -70,000(1 - 0.35) + 57,000 * 0.35

= -45,500 + 19950

= -25,550

(note: amount of $70,000 is out flow that's why we have taken negative sign)

discount rate = 10%

PVIFA( n = 6 ; r = 10%) = 4.35526069943

NPV = -342,000 - 25,550 * 4.35526069943

= -342,000 - 111276.91

= -453,276.91