Kolby’s Korndogs is looking at a new sausage system with an installed cost of $675,000. This cost will be depreciated straight-line to zero over the project’s 5-year life, at the end of which the sausage system can be scrapped for $89,000. The sausage system will save the firm $191,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $43,000. If the tax rate is 24 percent and the discount rate is 8 percent, what is the NPV of this project?
| Time line | 0 | 1 | 2 | 3 | 4 | 5 | |||
| Cost of new machine | -675000 | ||||||||
| Initial working capital | -43000 | ||||||||
| =Initial Investment outlay | -718000 | ||||||||
| 100.00% | |||||||||
| Savings | 191000 | 191000 | 191000 | 191000 | 191000 | ||||
| -Depreciation | Cost of equipment/no. of years | -135000 | -135000 | -135000 | -135000 | -135000 | 0 | =Salvage Value | |
| =Pretax cash flows | 56000 | 56000 | 56000 | 56000 | 56000 | ||||
| -taxes | =(Pretax cash flows)*(1-tax) | 42560 | 42560 | 42560 | 42560 | 42560 | |||
| +Depreciation | 135000 | 135000 | 135000 | 135000 | 135000 | ||||
| =after tax operating cash flow | 177560 | 177560 | 177560 | 177560 | 177560 | ||||
| reversal of working capital | 43000 | ||||||||
| +Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 67640 | |||||||
| +Tax shield on salvage book value | =Salvage value * tax rate | 0 | |||||||
| =Terminal year after tax cash flows | 110640 | ||||||||
| Total Cash flow for the period | -718000 | 177560 | 177560 | 177560 | 177560 | 288200 | |||
| Discount factor= | (1+discount rate)^corresponding period | 1 | 1.08 | 1.1664 | 1.259712 | 1.360489 | 1.4693281 | ||
| Discounted CF= | Cashflow/discount factor | -718000 | 164407.4074 | 152229.0809 | 140952.8527 | 130511.9 | 196144.08 | ||
| NPV= | Sum of discounted CF= | 66245.32 | |||||||
Kolby’s Korndogs is looking at a new sausage system with an installed cost of $675,000. This...
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