Question

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $675,000. The asset qualifies for 100 percent bonus depreciation and can be scrapped for $89,000 at the end of the project’s 5-year life. The sausage system will save the firm $191,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $43,000. If the tax rate is 24 percent and the discount rate is 8 percent, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Solution:

Calculation of NPV

a)Initial cash outlays=Cost of machine+Net working capital

=$675,000+$43,000

=$718,000

b)After tax sale value of machine at the end of project

book value of machine at the end of project is 0,as the 100% depreciation is claimed in first year.Hence after tax sale value is;

=Sale value*(1-tax rate)

=$89,000*(1-0.24)

=$67,640

c)Satement showing after tax casgh flows and its present value

Year	1	2	3	4	5
Cost saved	$191,000	$191,000	$191,000	$191,000	$191,000
Less:depreciation(100%)	$675,000	0	0	0	0
Net cost saved	($484,000)	$191,000	$191,000	$191,000	$191,000
Less:Tax @24%	0	$45,840	$45,840	$45,840	$45,840
After tax cost saving	($484,000)	$145160	$145160	$145160	$145160
Add:depreciation	$675,000	00	0	0	0
Add:after tax sale value of machine	0	0	0	0	$67,640
After tax cash inflows(a)	$191,000	$145160	$145160	$145160	$212,800
Present value factor@8%(b)	0.925926	0.857339	0.793832	0.73503	0.680583
Present value of cash inflows(a*b)	$176,851.87	$124,451.33	$115,232.65	$106,696.95	$144,828.06

NPV=Sum of Present vaalue of cash inflows-Initial cash outlays

Sum of Present value of cash inflows is;

=$(176,851.87+124,451.33+115,232.65+106,696.95+144,828.06)

=$668,060.86

NPV=$668,060.86-$718,000

=-$49,939.14

NPV of the project is $49,939.14(negative)