Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $530,000. 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 $87,000. The sausage system will save the firm $168,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $33,500. If the tax rate is 25 percent and the discount rate is 13 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

NPV of the project is calculated below:

Particulars	Remark	0	1	2	3	4	5
Cost reduction	Given		1,68,000.00	1,68,000.00	1,68,000.00	1,68,000.00	1,68,000.00
Depreciation	530000/5		1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00
EBT	Cost reduction-Depreciation		62,000.00	62,000.00	62,000.00	62,000.00	62,000.00
Tax	25% x EBT		15,500.00	15,500.00	15,500.00	15,500.00	15,500.00
EAT	EBT-Tax		46,500.00	46,500.00	46,500.00	46,500.00	46,500.00
Depreciation	Added back as non cash		1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00
OCF	EAT+Depreciation		1,52,500.00	1,52,500.00	1,52,500.00	1,52,500.00	1,52,500.00
FCINV	Given	-5,30,000.00
WCINV	Given	-33,500.00					$    33,500.00
Salvage value	Given						$    87,000.00
Tax on profit from sale	25% x (Salvage value - BV)						$   -21,750.00
FCF	OCF+FCINV	-5,63,500.00	1,52,500.00	1,52,500.00	1,52,500.00	1,52,500.00	2,51,250.00
Discount factor Formula	at 13 %	1/(1+0.13)^0	1/(1+0.13)^1	1/(1+0.13)^2	1/(1+0.13)^3	1/(1+0.13)^4	1/(1+0.13)^5
Discount factor	Calculated using above formula	1.00	0.88	0.78	0.69	0.61	0.54
DCF	FCF x Discount Factor	-5,63,500.00	1,34,955.75	1,19,429.87	1,05,690.15	93,531.11	1,36,368.43
NPV = sum of all DCF	26,475.31

• As per convention, Working capital investment is recovered at the end of the project until otherwise specified
• Depreciation = 530000/5 = 106,000
• As the equipment was fully depreciated so the entire salvage value was a profit and therefore it will be taxed which is a cash outflow while the salvage value is an inflow.
• As NPV = 26475.31 is positive, the project should be undertaken