Hot Dog stand is looking at a new sausage cooker with an installed cost of $54,000. This...

Hot Dog stand is looking at a new sausage cooker with an installed cost of $54,000. This cost will be depreciated straight line to $0 over its useful life of 3 years, at which time it is hoped it can be sold for scrap for $3,000. The cooker should save the company $25,000 per year in pretax operating costs. It requires an initial increase in net working capital of $3,000. If the tax rate is 35% and the weighted average cost of capital is 8%, should the Hot Dog stand buy the cooker?

WHAT is NPV?

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Expert Solution

Time line		0	2	2	3



Cost of new machine		-54000
Initial working capital		-3000
=Initial Investment outlay		-57000



savings			25000	25000	25000


-Depreciation	Cost of equipment/no. of years		-18000	-18000	-18000

=Pretax cash flows			7000	7000	7000
-taxes	=(Pretax cash flows)*(1-tax)		4550	4550	4550
+Depreciation			18000	18000	18000
=after tax operating cash flow			22550	22550	22550

reversal of working capital					3000

+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				1950
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					4950

Total Cash flow for the period		-57000	22550	22550	27500
Discount factor=	(1+discount rate)^corresponding period	1	1.1664	1.1664	1.259712
Discounted CF=	Cashflow/discount factor	-57000	19332.99	19332.9904	21830.387
NPV=	Sum of discounted CF=	3496.36742

Buy as nPV is positive

jeff jeffy answered 1 year ago

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