Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $530,400. 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 $81,600. The sausage system will save the firm $163,200 per year in pretax operating costs, and the system requires an initial investment in net working capital of $38,080.

  

If the tax rate is 21 percent and the discount rate is 10 percent, what is the NPV of this project?

Answer 1

Annual depreciation = 530,400 / 9 = 58,933.3333

Initial investment = Cost + net working capital

Initial investment = 530,400 + 38,080 = 568,480

OCF from year 1 to year 9 = (Savings - depreciation)(1 - tax) + depreciation

OCF from year 1 to year 9 = (163,200 - 58,933.3333)(1 - 0.21) + 58,933.3333

OCF from year 1 to year 9 = 141,304

Year 9 non operating cash flow = Market value + NWC - tax(market value - book value)

Year 9 non operating cash flow = 81,600 + 38,080 - 0.21(81,600 - 0)

Year 9 non operating cash flow = 81,600 + 38,080 - 17,136

Year 9 non operating cash flow = 102,544

NPV = Present value of cash inflows - present value of cash outflows

NPV = -568,480 + 141,304 / (1 + 0.1)¹ + 141,304 / (1 + 0.1)² + 141,304 / (1 + 0.1)³ + 141,304 / (1 + 0.1)⁴ + 141,304 / (1 + 0.1)⁵ + 141,304 / (1 + 0.1)⁶ + 141,304 / (1 + 0.1)⁷ + 141,304 / (1 + 0.1)⁸ + 141,304 / (1 + 0.1)⁹ + 102,544 / (1 + 0.1)⁹

NPV = $288,781.77