Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $343,200. This cost will be depreciated straight-line to zero over the project's 4-year life, at the end of which the sausage system can be scrapped for $52,800. The sausage system will save the firm $105,600 per year in pretax operating costs, and the system requires an initial investment in net working capital of $24,640.

  

If the tax rate is 24 percent and the discount rate is 16 percent, what is the NPV of this project?

Multiple Choice

• $-72,040.63

• $-61,009.08

• $-52,372.20

• $-38,846.74

• $-49,878.29

Answer 1

Answer is -$49,878.29

Initial Investment = $343,200
Useful Life = 4 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $343,200 / 4
Annual Depreciation = $85,800

Initial Investment in NWC = $24,640

Salvage Value = $52,800

After-tax Salvage Value = $52,800 * (1 - 0.24)
After-tax Salvage Value = $40,128

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $105,600 * (1 - 0.24) + 0.24 * $85,800
Annual Operating Cash Flow = $105,600 * 0.76 + 0.24 * $85,800
Annual Operating Cash Flow = $100,848

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$343,200 - $24,640
Net Cash Flows = -$367,840

Year 1 to Year 3:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $100,848

Year 4:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $100,848 + $24,640 + $40,128
Net Cash Flows = $165,616

Required return = 16%

NPV = -$367,840 + $100,848/1.16 + $100,848/1.16^2 + $100,848/1.16^3 + $165,616/1.16^4
NPV = -$49,878.29