Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $444,600. 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 $68,400. The sausage system will save the firm $136,800 per year in pretax operating costs, and the system requires an initial investment in net working capital of $31,920. If the tax rate is 31 percent and the discount rate is 15 percent, the NPV of this project is..........?

Answer 1

Initial Investment = $444,600
Useful Life = 3 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $444,600 / 3
Annual Depreciation = $148,200

Initial Investment in NWC = $31,920

Salvage Value = $68,400

After-tax Salvage Value = $68,400 * (1 - 0.31)
After-tax Salvage Value = $47,196

Annual OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual OCF = $136,800 * (1 - 0.31) + 0.31 * $148,200
Annual OCF = $140,334

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$444,600 - $31,920
Net Cash Flows = -$476,520

Year 1:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $140,334

Year 2:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $140,334

Year 3:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $140,334 + $31,920 + $47,196
Net Cash Flows = $219,450

Required return = 15%

NPV = -$476,520 + $140,334/1.15 + $140,334/1.15^2 + $219,450/1.15^3
NPV = -$104,085.83

The NPV of this project is -$104,085.83 or -$104,086