Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $787,800. This cost will be depreciated straight-line to zero over the project's 3-year life, at the end of which the sausage system can be scrapped for $121,200. The sausage system will save the firm $242,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $56,560.

  

If the tax rate is 24 percent and the discount rate is 16 percent, what is the NPV of this project?

Answer 1

Initial Investment Cost

Initial Investment Cost = Initial Cost + Working capital needed

= $787,800 + $56,560

= $844,360

Annual Cash Inflow

Annual Cash Inflow = Pre-tax Savings(1 – Tax Rate) + (Depreciation x Tax Rate)

= $242,400(1 – 0.24) + [($787,800 / 3 Years) x 0.24]

= [$242,400 x 0.76] + [$262,600 x 0.24]

= $184,224 + $63,024

= $247,248

Year 1 Cash Flow = $247,248

Year 2 Cash Flow = $247,248

Year 3 Cash Flow = Annual cash flow + Salvage Value after-tax + Release of working capital

= $247,248 + [$121,200(1 – 0.24)] + $56,560

= $247,248 + $92,112 + $56,560

= $395,920

Net Present Value (NPV) of the Project

Year	Annual Cash Flow ($)	Present Value factor at 16%	Present Value of Cash Flow ($)
1	2,47,248	0.862069	2,13,144.82
2	2,47,248	0.743163	1,83,745.54
3	3,95,920	0.640658	2,53,649.19
TOTAL			6,50,539.55

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $6,50,539.55 - $844,360

= -$193,820.45 (Negative NPV)

“Hence, the Net Present Value (NPV) of the Project would be -$193,820.45 (Negative NPV)”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.