Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $435,000. 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 $49,000. The sausage system will save the firm $137,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $24,000. If the tax rate is 21 percent and the discount rate is 9 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 = $435,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $435,000 / 5
Annual Depreciation = $87,000

Initial Investment in NWC = $24,000

Salvage Value = $49,000

After-tax Salvage Value = $49,000 * (1 - 0.21)
After-tax Salvage Value = $38,710

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $137,000 * (1 - 0.21) + 0.21 * $87,000
Annual Operating Cash Flow = $137,000 * 0.79 + 0.21 * $87,000
Annual Operating Cash Flow = $126,500

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$435,000 - $24,000
Net Cash Flows = -$459,000

Year 1 to Year 4:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $126,500

Year 5:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $126,500 + $24,000 + $38,710
Net Cash Flows = $189,210

Required return = 9%

NPV = -$459,000 + $126,500/1.09 + $126,500/1.09^2 + $126,500/1.09^3 + $126,500/1.09^4 + $189,210/1.09^5
NPV = $73,798.08

NPV of the project is $73,798.08