Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $515,000. This cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the sausage system can be scrapped for $81,000. The sausage system will save the firm $153,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $32,000. If the tax rate is 22 percent and the discount rate is 10 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 = Cost + working capital

Initial investment = 515,000 + 32,000

Initial investment = 547,000

Annual depreciation = 515,000 / 5 = 103,000

Operating costs from year 1 to year 5 = (Pre tax costs - depreciation)(1 - tax) + depreciation

Operating costs from year 1 to year 5 = (153,000 - 103,000)(1 - 0.22) + 103,000

Operating costs from year 1 to year 5 = 142,000

Year 8 non operating cash flow = Market value + net working capital - tax(market value - book value)

Year 8 non operating cash flow = 81,000 + 32,000 - 0.22(81,000 - 0)

Year 8 non operating cash flow = 81,000 + 32,000 - 17,820

Year 8 non operating cash flow = 95,180

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

NPV = Annuity * [1 - 1 / (1 + r)ⁿ] / r - initial investment

NPV = 142,000 * [1 - 1 / (1 + 0.1)⁵] / 0.1 + 95,180 / (1 + 0.1)⁵ - 547,000

NPV = (142,000 * 3.79079)+ 59,099.29153 - 547,000

NPV = $50,391.01