Question

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $680,000. 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 $90,000. The sausage system will save the firm $193,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $45,000. If the tax rate is 25 percent and the discount rate is 9 percent, what is the NPV of this project?

Answer 1

Answer :

Depreciation = $ 680,000 / 5 years = $ 136,000 per year

Annual Cash flow = Pre-tax savings ( 1 - tax rate) + ( depreciation * tax rate )

= $193,000 ( 1 - 0.25 ) + ( $136,000 * 0.25 )

= $144,750 + $34,000

= $178,750

Year 1 - 4 cash flow = $178,750

Year 5 cash flow = Annual cash flow + Release of working capital + Scrap value after tax

= $178,750 + $45,000 + [ $90,000 * ( 1 - 0.25 ) ]

= $178,750 + $45,000 + $67,500

= $291,250

Initial investment = Cost of the asset + Net working capital need

= $680,000 + $45,000

= $725,000

Net Present Value (NPV) of the project :

Year	Net cash flow	Present value factor at 9%	Present value of cash flow
1	$178,750	0.9174	$163,985.25
2	$178,750	0.8417	$150,453.88
3	$178,750	0.7722	$138,030.75
4	$178,750	0.7084	$126,626.50
5	$291,250	0.6499	$189,283.38
		Total =>	$768,379.76

Net Present Value (NPV) of the project = Present value of annual cash flows - Initial investment

= $768,379.76 - $725,000

= $43,379.76