Net present value, with taxation and intangible benefits

Terang Ltd is considering investing in new production line equipment which will significantly reduce manufacturing costs.The company has identified two options:

Option A would have a lower initial cost but would require a significant maintenance overhaul after three years.

Option B would require no maintenance overhaul and have a salvage value at the end of its useful life.

The company's cost of capital is 9% (after tax) and the company tax rate is 30%.Both options A and B are depreciable for tax purposes at 20% per annum on a straight line basis.The following estimates (before tax) relating to the two options have been provided:

Option AOption B

Initial cost$90,000$170,000

Annual cash inflows$180,000$150,000

Annual cash outflows$140,000$108,000

Maintenance overhaul (Year 3)*$12,000$--

Salvage value (non-taxable)$--$26,000

Estimated useful life6 years6 years

* Fully deductible for taxation purposes.

(a)Calculate the net present value and profitability index for each option.

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(b)Should an investment be made?If so, is option A or B preferred?

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(c)If an investment in new equipment is made, it is expected that this will significantly reduce the risk of injuries to factory employees.How might this be taken account of in the capital budgeting process?

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