CBOE Manufacturing is trying to decide between two different conveyor belt syste

Question

CBOE Manufacturing is trying to decide between two different conveyor belt systems. System A costs $448,000, has a 5-year life, and requires $122,000 in pretax annual operating costs. System B costs $566,000, has a 8-year life, and requires $76,000 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. If the tax rate is 31 percent and the discount rate is 19 percent, the NPV for project A is $ and the NPV for project B is $ . Therefore, the firm should choose project . (Do not include the dollar signs ($). Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Hi,

Please find the detailed answer as follows:

System A:

Initial Investment = -448000

Annual Operating Cost = 122000*(1-.31) = 84180 - 448000/5*(.31) = 56404

NPV = -448000 - 56404/(1+.19)^1 - 56404/(1+.19)^2 - 56404/(1+.19)^3 - 56404/(1+.19)^4 - 56404/(1+.19)^5 = -620462.84

System B:

Initial Investment = -566000

Annual Operating Cost = 76000*(1-.31) = 52440 - 566000/8*(.31) = 30507.50

NPV = - 566000 - 30507.50/(1+.19)^1 - 30507.50/(1+.19)^2 - 30507.50/(1+.19)^3 - 30507.50/(1+.19)^4 - 30507.50/(1+.19)^5 - 30507.50/(1+.19)^6 - 30507.50/(1+.19)^7 - 30507.50/(1+.19)^8 = -686637.81

System A should be chosen.

Thanks.

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