Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $897,000. This cost will be depreciated straight-line to zero over the project's 9-year life, at the end of which the sausage system can be scrapped for $138,000. The sausage system will save the firm $276,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $64,400. Required: If the tax rate is 33 percent and the discount rate is 13 percent, what is the NPV of this project?

Answer 1

Initial Investment for the Project

Initial Investment for the Project = Cost of the asset + Working capital needed

= $897,000 + $64,400

= $961,400

Annual Operating Cash Flow (OCF)

Annual Operating Cash Flow (OCF) = Pretax Savings(1 – Tax Rate) + (Depreciation x Tax Rate)

= [$276,000 x (1 – 0.33)] + [($897,000 / 9 Years) x 0.33]

= [$276,000 x 0.67] + [$99,666.67 x 0.33]

= $184,920 + $32,890

= $217,810

Year 1-8 Cash flow = $217,810

Year 9 Cash flow = Annual operating cash flow + Release of working capital -After-Tax Salvage value

= $217,810 + $64,400 + [$138,000 x (1 – 0.33)]

= $217,810 + $64,400 + [$138,000 x 0.67]

= $217,810 + $64,400 + $92,460

= $374,670

Net Present Value of the Project

Year	Annual Cash Flow ($)	Present Value factor at 13.00%	Present Value of Cash Flow ($)
1	2,17,810	0.8849558	1,92,752.21
2	2,17,810	0.7831467	1,70,577.18
3	2,17,810	0.6930502	1,50,953.26
4	2,17,810	0.6133187	1,33,586.95
5	2,17,810	0.5427599	1,18,218.54
6	2,17,810	0.4803185	1,04,618.18
7	2,17,810	0.4250606	92,582.46
8	2,17,810	0.3761599	81,931.38
9	3,74,670	0.3328848	1,24,721.96
TOTAL			11,69,942.12

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

= $11,69,942.12 - $961,400

= $208,542.12

“Hence, the NPV for this Project will be $208,542.12”

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.