Question

Project EvaluationDog Up! Franks is looking at a new sausage system with an installed cost of $375,000. 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 $25,000. The sausage system will save the firm $95,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $15,000. If the tax rate is 24 percent and the discount rate is 10 percent, what is the NPV of this project? Chapter 6 question 8

Answer 1

INITIAL INVESTMENT:
Installed cost of new system	$     3,75,000
Increase in NWC	$         15,000
Initial cash outflow	$     3,90,000
ANNUAL OCF:
Savings in operating costs	$         95,000
Depreciation [375000/5]	$         75,000
Incremental NOI	$         20,000
Tax at 24%	$           4,800
Incremental NOPAT	$         15,200
Add: Depreciation	$         75,000
Incremental OCF	$         90,200
TERMINAL NON OPERATING CASH FLOWS:
After tax salvage value = 25000*(1-24%) =	$         19,000
Release of NWC	$         15,000
After tax terminal operating cash flow	$         34,000
NPV:
PV of annual OCF = 90200*(1.1^5-1)/(0.1*1.1^5) =	$     3,41,929
PV of terminal cash flow = 34000/1.1^5 =	$         21,111
Total PV of cash inflows	$     3,63,040
Less: Initial investment	$     3,90,000
NPV	$       -26,960
The project should not be accepted as the NPV is negative.