Question

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $695,000. This cost will be depreciated straight-line to zero over the project’s 5-year life, at the end of which the sausage system can be scrapped for $93,000. The sausage system will save the firm $199,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $51,000. If the tax rate is 23 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

Initial investment = Fixed asset investment + increase in NWC

Initial investment = 695,000 + 51,000

Initial investment = 746,000

Annual depreciation = 695,000 / 5

Annual depreciation = 139,000

Operating cash flow from year 1 to year 5 = (Savings - depreciation)(1 - tax) + depreciation

Operating cash flow from year 1 to year 5 = (199,000 - 139,000)(1 - 0.23) + 139,000

Operating cash flow from year 1 to year 5 = 46,200 + 139,000

Operating cash flow from year 1 to year 5 = 185,200

Year 5 non operating cash flow = Scrap value + recovery of NWC - tax(scrap value - book value)

Year 5 non operating cash flow = 93,000 + 51,000 - 0.23(93,000 - 0)

Year 5 non operating cash flow = 93,000 + 51,000 - 21,390

Year 5 non operating cash flow = 122,610

NPV = Presnet value of cash inflows - present value of cash outflows

NPV = Annuity * [1 - 1 / (1 + rate)^time] / rate + Face value / (1 + rate)^time - Initial investment

NPV = 185,200 * [1 - 1 / (1 + 0.08)^5] / 0.08 + 122,610 / (1 + 0.08)^5 - 746,000

NPV = 185,200 * [1 - 0.68058] / 0.08 + 83,446.30579 - 746,000

NPV = 185,200 * 3.99271 + 83,446.30579 - 746,000

NPV = $76,896.20