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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
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