Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $495,000. This cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the sausage system can be scrapped for $73,000. The sausage system will save the firm $149,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $30,000.

If the tax rate is 23 percent and the discount rate is 11 percent, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $495,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $495,000 / 5
Annual Depreciation = $99,000

Initial Investment in NWC = $30,000

Salvage Value = $73,000

After-tax Salvage Value = $73,000 * (1 - 0.23)
After-tax Salvage Value = $56,210

Annual Operating Cash Flow = Pretax Costing Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $149,000 * (1 - 0.23) + 0.23 * $99,000
Annual Operating Cash Flow = $137,500

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$495,000 - $30,000
Net Cash Flows = -$525,000

Year 1 - Year 4:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $137,500

Year 5:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $137,500 + $30,000 + $56,210
Net Cash Flows = $223,710

Required return = 11%

NPV = -$525,000 + $137,500/1.11 + $137,500/1.11^2 + $137,500/1.11^3 + $137,500/1.11^4 + $223,710/1.11^5
NPV = $34,347.28

So, NPV of the project is $34,347.28