Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $460,000. 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 $59,000. The sausage system will save the firm $142,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $26,500.

If the tax rate is 21 percent and the discount rate is 9 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

For the calculation of NPV, we need to calculate the cash inflows and cash outflows but as we know that a project involves cash flows at different intervals so we have to discount the cash flows first.

COMPUTATION OF CASH FLOWS

1. CASH OUTFLOWS	AMT($)
COST OF NEW SAUSAGE SYSTEM	460000
ADD: ADDITIONAL INVESTMENT FOR WORKING CAPITAL	26500
TOTAL	486500

2. ANNUAL CASH FLOWS AFTER TAX	AMT($)
CASH FLOW BEFORE TAX	142000
LESS: DEPRECIATION*	80200
EBIT =EBT	61800
LESS: TAX@21%	12978
EARNINGS AFTER TAX	48822
ADD BACK: DEPRECIATION	80200
CASH FLOW AFTER TAX(CFAT)	129022

*DEPRICIATION=(460000-59000)/5=80200

3. TERMINAL CASH FLOWS	AMT($)
SALVAGE VALUE OF NEW MACHINE	59000
RELEASE OF WORKING CAPITAL	26500
TOTAL	85500

4. COMPUTATION OF NPV OF CASH FLOWS	AMT($)
PRESENT VALUE OF ANNUAL CFAT: 129022*3.88 (PVAF 9%,5YEARS)	500605.36
PRESENT VALUE OF TERMINAL CASH INFLOWS: 85500*0.65 (PVF 9%,5YEARS)	55575
TOTAL PV OF CASH INFLOWS	556180.36
LESS: PV OF CASH OUTFLOWS	486500
NPV	69680.36

AS THE NPV IS POSITIVE, SO THE INVESTMENT SHOULD BE MADE.